All roads lead to Chapter 9 for Detroit

City's financial crisis edges closer to bankruptcy

By Rod Meloni - Reporter, CFP ®

DETROIT - Let's cut to the chase here: Detroit City Council is on the road to approve a consent agreement that is like using a squirt gun on a general alarm fire.

The only way to solve Detroit's financial problems is a Chapter 9 Municipal Bankruptcy. You may recall you read similar sentiments here before and after the work I've done watching the circus the consent agreement process has become I am now more convinced than ever the only way out of this mess is through the bankruptcy process.

There are many in the city of Detroit who will disagree with this notion; many who believe there are ways for the city to solve its own problems. They sell the soap there are ways to continue operating just the way the city has for generations; especially if the state of Michigan would simply pay the money, the $220 million "it owes" to the city of Detroit.

Michigan Treasurer Andy Dillon admits Detroit should have received that money. He says it is unfortunate that money did not come in but he is absolutely correct when he points out $220 million would be a drop in the bucket and would in no way solve Detroit's immediate or long term financial problems.

It ignores one important fact that plays into whether the State would simply "pony up" the cash "Detroit deserves."

Every other municipality in the state of Michigan lost revenue sharing dollars over the past decade as well and if the state pays Detroit it must pay everyone. The state may have a small surplus but it is in no position to pay that kind of money. That would also require a Legislative vote to do so and there is no appetite in Lansing to do anything of the kind. For those who believe state dollars injected into the consent agreement would solve this problem; they too are wrong. The state does not and will not ever have enough money to solve Detroit's financial problems.

You may doubt me, but allow me to draw your attention to the definition of insolvency.

Investopedia defines it as "a situation where the value of a company's liabilities exceeds its assets." The State Review Team estimates the state's debt to asset ratio [assets divided by liabilities] as 33 to 1 in the NEGATIVE!

READ: Detroit review team report

But let's get to the real dollar amounts. Detroit owes $17 billion dollars [including debt interest] and its assets are listed at roughly half a billion dollars. No one in the state of Michigan has the money to cover these kinds of deficits that have been rung up by irresponsible city leaders over the last 50 years. No one person is responsible, no small group of leaders is responsible but in the end the entire lot of them is. They share the blame for not balancing the books and instead borrowing boatloads of money to kick the can down the road. That can has finally clanked up against a stone wall.

So, let's look at the landscape and realize there is one solution. The only remedy that is available to solve problems if this magnitude is Chapter 9 Municipal Bankruptcy, a reset button hit and managed by one federal judge who will decide what Detroit will look like in the future. General Motors, Chrysler, Kmart and Greektown Casino all used it, virtually every auto supplier in metro Detroit from Delphi to Lear used it during the auto meltdown, and many cities across the United States in the near future will use it too. In reality, Detroit will be on the vanguard of a disturbing but necessary trend. [Los Angeles apparently is on the brink of Chapter 9 too.]

I have had the displeasure of getting a front row seat to all of those bankruptcies. I have learned a thing or two about the subject over the years. I have become friends with many bankruptcy experts who all tell me one thing. It takes about two minutes to look at a balance sheet to tell whether a company [or city] will wind up in bankruptcy. No one with an ounce of turn around acumen will disagree that a 33 to on 1 [in the negative] debt to asset ratio not only means bankruptcy, it would be just this side of criminal to suggest otherwise.

So how will this work? Well, Public Act 4 tells us the only way in Michigan right now to go into Chapter 9 municipal bankruptcy is through an emergency manager. The governor is in no mood right now to assign one. But it is more than likely over the next year of so the governor will find himself in the position to have to appoint one mainly because there is no amount of budget cutting that can deal with $17 billion of debt. So, not if, but when an emergency manger will have the chance to look at the books, work on a plan and Public Act 4 says if he or she deems the plan working on fixing the city's long term problems can not get the job done, or if after six months it becomes clear that nothing will solve the debt problem then he or she can request the governor of Michigan to approve a Chapter 9 Municipal Bankruptcy.

Now, that is a lot of steps, and not a one of them is politically palatable. The governor does not want to do any of this and will likely wait until it is absolutely necessary to pull the trigger on bankruptcy. There are those who will say Public Act 4 is unconstitutional and indeed there are probably enough signatures to have a statewide vote on the question of whether to approve Public Act 4. I will make no predictions that will work out. But let's just say, if Public Act 4 goes down in flames at the polls, nothing changes. In fact, it would greatly increase the Chapter 9 odds.

Still, remember you read it here first; bankruptcy is the one and only solution. It will come; maybe not in a day or a week or even a month, but all roads lead to Chapter 9.

If you don't believe me take a minute and watch the video of my 6 p.m. story tonight, Van Conway is one of the most respected bankruptcy experts/executives in the country. He says it, others of his ilk say it, believe it.

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