We are years away from understanding the full impact and consequences of Detroit’s recent decision to file a Chapter 9 Bankruptcy. There will be lawsuit after lawsuit and motion after motion to determine what and how the Courts will handle the Country’s largest municipal bankruptcy. The current estimates have us at about $18 Billion debt which is more than 4 times higher than the second biggest (Jefferson County with $4billion of debt)!
What I Fear the Detroit Bankruptcy will Do To Personal Finance
I won’t even pretend to know exactly what is going to happen, even bankruptcy experts do not know where the Court will land. Notwithstanding I do know that there are two items that are part of a very real debate in terms of restructuring:
- General Obligation Bonds
I am not sure how likely it is that either really get touched, but if either one does it will have repercussions that will literally affect every single American if not the every single person in the civilized world…and yet no one is really talking about it? and I can’t figure out why!
General Obligation Bonds and the Detroit BANKRUPTCY
According to Investopedia a General Obligation bond is,
A municipal bond backed by the credit and “taxing power” of the issuing jurisdiction rather than the revenue from a given project.
General obligation bonds are issued with the belief that a municipality will be able to repay its debt obligation through taxation or revenue from projects. No assets are used as collateral
Well, what happens if the 18th largest City in America by population decides (and gets permission) to take all their general obligation bonds which according to Yahoo is approximately $1.13 Billion (with a B) and decides to give their holders pennies on the dollar? What will that due to the municipal debt market? Would sure as hell make everyone look at the bonds they hold and the holdings of every bond fund a tad closer.
Lets say that the Chapter 9 went smoothly and Detroit was able to effectively erase $500mil of the $1+ Billion of debt, what do you think is going to happen next? You are simply nuts if you don’t believe that another city will follow suit. Chicago recently had its bond rating triple downgraded! That is a shit ton more serious than:
How long until Chicago just says, “Screw it, Detroit got out from underneath its debt with a Chapter 9 Filing?” and then the next city? This will completely change the landscape of municipal bonds. Maybe that change is a good thing, but no matter what it will be a painful trip there.
How Will Detroit’s Bankruptcy Affect Pensioners
To be frank, no one knows yet what will happen to retired, near retired or just plain working folk of Detroit that are currently or will be using the pension system. Some articles I have read indicate that there is a real chance pension income will be cut while other articles seem to rely on Michigan Constitution Protection. It has been an extremely long time since law school but I have no idea what the affect a State’s Constitution will have on Federal bankruptcy proceedings.
While I think there should be no new government employees on a pension , there is something to be said about all those who had a promise made by them by their government employer that if you worked X years you will have Y income coming to you. I am giving it a 50-50 chance that people see a reduction in their monthly check.
Again, if other cities can reduce their severely underfunded pension obligations with a Chapter 9 proceeding who do you think will file next? Maybe Chicago? Maybe Philly or Pittsburgh? What about every major City in the State of California?
Detroit’s Bankruptcy Means There are No Guarantees With Personal Finance
There are a large percentage of current retirees and near retirees that are dependent on municipal bond income along with their pension to survive. In the future that just may not be enough!
For me, I would like to see that risk shifted to a multitude of entities. This would not only include your different municipalities and governments (federal, state and local bonds), as well as different insurance companies that have been around for 100+ Years and even some limited exposure to blue chip stocks.