Will Detroit’s bankruptcy affect your hometown?
It’s a question many in local governments across the state have been asking themselves lately.
There are a couple ways Detroit’s bankruptcy could have a bad influence on other local governments.
The simple way: not so good national media attention
The simplest way is all that bad press the nation’s biggest municipal bankruptcy will bring. But Detroit’s finances have been screwed up for decades. That’s not news. Economists that track indicators in West Michigan say it won’t help, but they do not expect this to be a big factor.
The more important way Detroit’s bankruptcy could affect small governments is much more complicated.
The complicated way: “unprecedented” threats to municipal bonds
First, you’ve got to understand these bonds are really important to local governments.
Jessalynn Moro is a managing director of local government ratings at Fitch Ratings.
“Ratings are a credit opinion on the local government’s ability to pay back its debt, much like a personal credit score is supposed to reflect an individual person’s ability to pay back their debt,” Moro explained.
A local government might sell bonds to build a new school or a new jail, or repair flood walls. You’ve probably voted on some of these types of general obligation municipal bonds.
The better the bond rating a municipality has, the lower the interest payment and the more money it saves.
Moro says these kinds of bonds, especially unlimited-tax general obligation bonds, are supposed to be a pretty safe bet for investors.
“A city is basically selling the bonds and saying ‘we promise, and not only do we promise but we have a legal obligation to raise taxes to an unlimited degree in order to pay back that debt,” Moro said.
But with Detroit’s bankruptcy, the city is asking the judge to treat everyone it owes money the same; pensioners, bond holders, secured, unsecured, doesn’t matter.
That’s never happened with these supposedly secure municipal bonds. Other cities that have gone through bankruptcy have given bond holders special status so they get paid first.
“Really in the past it’s been thought of as untouchable. This is now challenging that,” explains Bob Donahue. He’s a managing director at Municipal Market Advisors.
How bond investors and ratings agencies are reacting
Donahue says some of his clients have already said they’re not interested in any Michigan bonds just because of the uncertainty. He called it “sort of a black eye” for the state as a whole.
“Very highly risk averse investors might choose to stay away from Michigan on principle because of this new kind of developing risk that has come out of the Detroit situation,” Donahue said. These investors could be mutual funds, insurance companies or those who invest for elderly people, he said.
If the federal judge agrees to treat all of Detroit’s creditors the same, people in the bond world say that could really change things for all of Michigan’s local governments.
That representative from Fitch Ratings we heard from earlier, Jessalynn Moro, says no doubt, Detroit’s request to treat secured and unsecured creditors the same was a surprise. She says they’re watching the bankruptcy closely.
Anne Van Praagh is managing director and chief credit officer for public sector ratings at Moody’s, another ratings agency. She expects cities, townships, counties, or school districts that are distressed could be affected more.
“If you exhibit any kind of fundamental credit weaknesses at this point you would be at a disadvantage trying to raise funds in this market given the questions that Detroit raises in the municipal market,” Van Praagh said.
Van Praagh says if the federal bankruptcy judge decides to set this kind of precedent, other cities struggling with their finances might turn to bankruptcy too. She thinks that could be the bigger issue.
She also notes that of the 7,500 municipalities Moody’s rates, only 34 of them are rated below investment grade.
"Detroit’s case is likely to influence both market expectations and behavior of other cities around the edges," Van Praagh said.
How local government leaders are reacting
The mayors and county executives I talked to in West Michigan are all aware of the potential impact on the bond market. It’s something they’ve got their eyes on. But they’re really not too concerned yet.
Oakland County Executive L. Brooks Patterson is a little more worried. He says some rating agency representatives warned him a few years ago that being sandwiched between Detroit and Flint could have a negative influence.
Patterson cannot believe Detroit’s emergency manager is even asking the judge to set such a precedent.
“The first time he said that, we all looked at each other and said ‘He can’t be serious.’ That’s a huge assault on the bond market,” Patterson said.
Right now, Oakland County has a perfect AAA bond rating. If it were downgraded just a notch or two, Patterson says it’ll cost him $2-3 million more each year. That could equate to higher taxes for people living in Oakland County or fewer projects or smaller projects or cuts in the budget from somewhere else.
Patterson’s hoping municipal bond holders won’t lose their special status like Detroit’s emergency manager wants.
“Now he’s got to sell that to the bankruptcy judge. I think the bankruptcy judge, hopefully, has enough experience to say ‘well we can’t do that.’ They are a privileged class. But if he lumps them in with the category of unsecured creditors we probably sold our last bond for a while,” Patterson said.
And it’s not just Oakland County we’re talking about. People in the bond market world say the judge’s decision on Detroit’s bankruptcy could affect local governments across the United States.
Oakland County has its annual review with the ratings agencies later this month. Patterson says he’s anxious to make his case that Oakland County is a stand-alone economy that’s not threatened by Detroit’s bankruptcy filing.
Governor Snyder on the threat: should the state do more?
Less than a year ago, Governor Rick Snyder was out on the campaign trail asking voters not to repeal P.A. 4; the emergency manager law he signed in 2011. At the time, part of his pitch was that the law was needed to help municipalities avoid bankruptcy.
“Bankruptcy has a lot of negative consequences. It is not a trivial act,” Snyder said during a stop in Grand Rapids in October 2012, a week before voters repealed P.A. 4. (Another version of the emergency manager law passed in December 2012.)
“It can have surrounding impact in terms of credit ratings for other people and consequences to the surrounding area or to the state," Snyder said.
But Snyder has changed his tune since then. At a stop in Muskegon last week, he told reporters Detroit’s bankruptcy shouldn’t affect communities in West Michigan.
“I mean as a practical matter each jurisdiction should stand on its own,” Snyder said. He admits there’s still speculation around this issue.
Sara Wurfel, a spokeswoman with Snyder’s office, says that’s part of the reason Snyder went on a sort of publicity tour after the bankruptcy filing. He appeared on a number of Sunday TV talk shows. She says he visited the editorial boards at The New York Times, Bloomberg, and The Wall Street Journal to reinforce the ways Michigan's economy is improving.
Wurfel says the magnitude and history of Detroit’s debt made it a unique situation. “It’s a path (Snyder) wanted to avoid. But given everything that’s happened, this came to be the last viable alternative,” Wurfel said.
Bob Donahue, with Municipal Market Advisors, thinks Snyder or lawmakers should’ve enacted a law protecting the status of bondholders, like Rhode Island did a couple of years ago when one of its cities declared bankruptcy.
“Bond investors would probably like to see him put his money where his mouth is and kind of spearhead some legislation that crystalizes the view that Michigan municipal bonds are safe. So far we haven’t seen that,” Donahue said.