Detroit Bankruptcy Filing: Implications for Investors

Source: Sarah Bush, Beth Foos, Jeff Westergaard, Morningstar Special Report, September 16, 2013
(registration required)

The City of Detroit filed for protection under Chapter 9 of the U.S. bankruptcy code on July 18, marking the largest Chapter 9 filing in U.S. history and the first in the State of Michigan. The move came after weeks of negotiations between the city’s state-appointed emergency manager and the city’s creditors, which resulted in a failure to produce a compromise on the restructuring of Detroit’s massive $19 billion of liabilities. Chapter 9 filings are rare, which makes searching for precedent to guide this very complicated case almost futile. However, the events in Detroit unfolding over the next several months and possibly years will force investors to confront some fundamental questions.

We believe this case could have momentous implications for several areas of the municipal market, including the sovereign rights of states versus the power of federal bankruptcy laws over protection of pension benefits, the market’s opinion of the fundamental security offered by the unlimited tax general obligation pledge, and the value that bond insurance may provide in the aftermath of the financial crisis. We can’t offer the answers to these pressing questions—those will only come with time and court rulings—but we can provide analysis and clarity regarding some of the major issues. In this article, we’ll detail the city’s liability profile, including bonded debt and unfunded pensions, look at the role of municipal bond insurance for investors holding Detroit debt, and highlight recent trading activity and market reactions to the events to date…