Municipal issuers around the U.S. shouldn’t be penalized because of a plan to force losses on some Detroit bondholders, said Kevyn Orr, the emergency manager who sought bankruptcy protection for Michigan’s biggest city.
“That’s irrational behavior because each underwriting should stand on its own,” Orr said in an interview yesterday at Bloomberg headquarters in New York. Lenders “want to send a shock to the system, to the market.”
Orr offered holders of $369 million of unlimited general-obligation bonds less than 20 cents on the dollar in a fiscal rescue plan floated before his record bankruptcy filing last week. His proposal sought to avoid a Chapter 9 reorganization to deal with about $18 billion in city liabilities. General obligations, which are supposed to be backed by taxpayers, are generally considered the safest part of the municipal market.
By offering less than full payment, Orr’s plan “undermines the sanctity” of such debt, according to Sheila Amoroso and Rafael Costas, co-directors of municipal investments for a unit of San Mateo, California-based Franklin Resources Inc. (BEN) Tax-backed general-obligation securities make up about $900 billion of the $3.7 trillion market, data compiled by Bloomberg show.
If Orr’s proposal takes effect, it “would be an unsettling precedent” for the municipal market, Amoroso and Costas said in a July 24 report.
“These are the harsh realities of the marketplace for a bankrupt enterprise,” Orr said regarding Detroit’s general-obligation bonds. He said that doesn’t mean other issuers are in the same boat, or present similar risks to investors.
Michigan Governor Rick Snyder, a Republican, seconded that opinion.
Investors “should be looking at the financial strength of that jurisdiction,” he said in an interview today at Bloomberg headquarters. “Isn’t that the point of having a prospectus, of having those bonds backed by that community?”
States and cities from California to New York use unlimited general-obligation bonds to build roads, bridges and schools. The issuers pledge to repay borrowings with tax receipts, and to use their power to impose levies high enough to cover the debt.
Detroit, where officials struggle to provide basic services such as policing and street lighting, joins Jefferson County, Alabama, and the California municipalities of Stockton and San Bernardino in trying to use bankruptcy to reduce debt. The Motor City, with about 700,000 residents, is the biggest community in U.S. history to enter court protection.
Creditors balked at Orr’s plan to avoid bankruptcy, and some sued in state courts trying to prevent a filing. Detroit’s municipal pensions as well as labor unions have also objected.
While Orr said he understands that the treatment of Detroit’s debt may have a widespread effect on the muni market in particular, he views his job as restoring the city to fiscal stability. He compared his task to a horse with blinders on, trying to stay in one lane to get to the final destination.
“My statute does not say that I have an obligation to take into account the larger macroeconomic and political aspects of the general-obligation bond market,” Orr said. “If I did that, where does it end?”
Detroit unlimited general-obligation bonds maturing April 2020 traded July 23 at an average of about 78.7 cents on the dollar, the lowest in at least a year, data compiled by Bloomberg show. The Ambac Assurance-backed debt had an average yield of about 9.6 percent.
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