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Detroit files for bankruptcy; largest American city to do so

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Photo courtesy of nairaland.com

By Chris Isidore/CNN Money —  Detroit filed for bankruptcy Thursday afternoon, becoming the nation’s largest public sector bankruptcy. The move could slash pension benefits to city workers and retirees, and leave bond holders with only pennies on the dollar.

The bankruptcy was filed by Emergency Manager Kevyn Orr and approved by Michigan Gov. Rick Snyder. Snyder said the financial condition of the city left him no choice, and that Detroit could not meet its obligation to either its citizens or its creditors.

“The only feasible path to ensuring the city will be able to meet obligations in the future is to have a successful restructuring via the bankruptcy process,” Michigan Gov. Rick Snyder said in the letter authorizing the filing.

But public employee unions are sure to fight the move.

Orr already halted payments on about $2 billion in debt last month, saying the city needed to preserve its dwindling supply of cash. The city faces total liabilities of about $18 billion. Orr’s reorganization plan calls for cutting $11.5 billion in debt down to $2 billion. That would mean that investors and retirees would receive an average of just 17% of what they are owed. Specific plans for the cuts are unknown at this time.

Detroit city employees, retirees: Tell us how this affects you

But cutting retiree’s pensions in a municipal bankruptcy has never been done before, said Michael Sweet, a California bankruptcy attorney.

“It’s relatively easy to blow off a creditor. It’s much harder when it’s people who are the fabric of your community,” he said. “You need a police force, you need a fire department. You’re saying [to them] you’re not worth what you were previously promised.”

Sweet said case law on whether pensions can be cut this way is very limited, and it could take years for a court fight over pension cuts to work its way to the U.S. Supreme Court. Given the poor state of funding for many public sector pension funds nationwide, “it’s a big enough question, that (the Supreme Court) is where it likely will have to go,” he said.

Related: Detroit halts debt payments, plans pension cuts

When employees of a bankrupt business lose their promised pensions, the Pension Benefit Guarantee Corp. steps in and provides a minimal level of benefits. But that federal agency doesn’t back pensions in the public sector.

Snyder spokeswoman Sara Wurfel said the decision to file for bankruptcy came after careful deliberation.

“This has been a huge problem for decades and it’s come to a crisis point,” she said. “The emergency manager tried to work with all the creditors, including pensioners.”

Retirees and city employees say they can’t accept cuts in their pension benefits.

“How am I supposed to live without my pension?” said David Sole, 65, after a protest in Detroit last month. Sole retired from the city’s water department in January after 22 years.

Investors say the bankruptcy will make it more difficult for cities and towns everywhere to raise the money they need to build bridges, schools and other infrastructure. It will also hurt municipal bonds held by individual investors. There are more than $1 trillion worth of bonds at risk, said Peter Hayes, head of municipal bonds at BlackRock. He said there will be a ripple effect nationwide.

Detroit may sell its art treasures

Orr said that the city needs to cut debt to restore services and lower costs, such as taxes and insurance, that he says have chased businesses and residents out of the city.

Detroit’s population has fallen 28% since 2000. The unemployment rate, while down from a peak of 27.8% in the summer of 2009 — when General Motors (GM, Fortune 500) and Chrysler Group were going through their own bankruptcies — is still at 16.3%, nearly twice Michigan’s statewide average.

While the auto industry has enjoyed a resurgence with strong car sales and profits, most of the industry’s Michigan plants lay outside of city limits.

– CNN’s Poppy Harlow contributed to this report.

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