When Detroit filed for bankruptcy last summer, it was clear that it would be a case like no other. Already the largest municipal bankruptcy in history, it also poked the bear in several ways. One was its proposed treatment of general obligation (GO) debt, a $900 billion segment of the $3.7 trillion municipal bond market generally seen as the most secure.
Last month, Detroit agreed to pay Unlimited-Tax General Obligation (UTGO) bondholders about 74% of the $388 million they are owed. This was up from Draconian proposals of as little as 15%, and it was received favorably by the market. But the deal, negotiated with three bond insurers, covers only UTGO debt. It does not cover the estimated $160 million in Limited-Tax General Obligation (LTGO) debt, and this is critically important, for several reasons:
- LTGO debt is the primary source of financing for hundreds of cities, towns and counties in Michigan.
- LTGO debt represents a roughly $5 billion market in Michigan.
- Because LTGO debt does not require voter approval, it is relatively easy for Michigan localities to obtain. And in a state where 12 municipalities (not to mention five school districts) are stressed and under some form of state oversight, access to borrowing is critical. LTGO debt is essential to keeping "all systems go" for taxpayers in a financially responsible fashion, by offering relatively low-cost financing within state-imposed debt limits.
If no agreement is reached in relation to LTGO debt, and a cram down at the end of the bankruptcy process leaves bondholders with the plan's estimate of 10-13 cents on the dollar (vs. the 74 cents afforded to UTGO debt), the implications for Michigan municipalities could be calamitous. It could engender a distrust of a popular and necessary form of financing -and one previously believed to be backed by a first-priority promise of repayment. An apprehensive market could demand higher (in fact, prohibitive) interest rates on the debt. Municipalities, unable to afford the borrowing costs, could struggle to support their systems and provide services, and could turn to more speculative sources of financing, increasing the risk of more costly bankruptcies. Market distrust of Michigan LTGO debt is an outcome that would not only hurt bondholders - it could harm residents.