All roads lead to Chapter 9: Part II

Rod Meloni looks back a year after 1st writing 'All roads lead to Chapter 9 for Detroit'

By Rod Meloni - Reporter, CFP ®
Headline Goes Here

DETROIT - On April 4, 2012, if you read my blog called "All Roads Lead to Chapter 9," you read the following: "Let's cut to the chase here: Detroit City Council approved a Consent Agreement this afternoon which 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."

Read back: All roads lead to Chapter 9: Part I

That same day I did a demonstration on the air of how bad the City of Detroit's financial problems were by displaying a carton of three dozen eggs. Thirty-three of those eggs represented the city's debt, one egg as the city's useful assets as a way to show an asset to liability equation. I did so using information provided by the State of Michigan's financial review team.

That piece made City Council member Kwame Kenyatta angry at me and on numerous occasions when he was able to be at the council table [he has had health issues and hasn't attended many meetings in his last year] he decried my analysis of the problem and said I was part of the problem. I have worn that mantle proudly. I spoke the truth then and my exceptionally sad prediction is bearing itself out.

Fast forward 14 months the City of Detroit is in Emergency Management. One week from today Emergency Manager Kevyn Orr will bring a couple hundred of Detroit's creditors to the Metro Detroit Airport Westin Hotel where he will drop a 200 page restructuring plan on them. It will streamline Detroit City operations, likely cutting hundreds if not thousands of jobs. He will explain to bondholders he will offer them pennies on the dollar of the near $17 billion in debt that is owed.

This will be the smash in the face, the bitter pill, the unwelcome ugliness everyone had hoped would never come. This is a negotiation position. Orr is taking the legal steps to prove he is negotiating in good faith with the city's creditors as a prerequisite to a Chapter 9 if it is necessary. This is how bankruptcy works. You try and hammer out an out of court settlement with as many creditors as possible. If and when that process fails then a bankruptcy plan is drawn up and the attorneys [and there will be hundreds of very highly paid lawyers] will bring the steaming pile of garbage to a bankruptcy judge who is then charged with taking the steam off and cleaning up the mess.

Here is another paragraph from that piece: "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 finally clanked up against a stone wall. 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."

Orr would love not getting to bankruptcy but the fact of the matter is that decision is likely out of his hands. Here is the wrinkle that has cropped up since April 2012. We have learned a lot about the City of Detroit's pension funds in the past 14 months. The police and fire and general fund pensions are a major problem. City Hall insiders have been saying, backed by an internal review done by the actuarial firm the Milliman Group, the City of Detroit pension funds are not nearly funded to the extent the internal auditors say they are.

Their estimates say the funding is 102 percent and 80 percent. Milliman says preliminary estimates put that funding more like 50 percent and 32 percent. But those same City Hall insiders tell me the work that's been done since that 2012 report shows those pension funds are probably not even 30 percent funded on a good day.

This is the unavoidable fulcrum that will force Chapter 9. It is the thing that, if in fact correct, will force Kevyn Orr's hand. The Federal Government requires paying defined benefit pensions. If a municipality can not the only way to solve the funding problem is to file for Chapter 9 Municipal Bankruptcy. This also means pensioners will likely lose most of their pension dollars. This is genuinely tragic business profligate spending over a half century brings.

In the end, I take no solace in being right, but the facts remain. To close I'll use the paragraph I used 14 months ago.

"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."

It's an exceptionally sad outcome indeed.

Copyright 2013 by All rights reserved. This material may not be published, broadcast, rewritten or redistributed.