By Agnes T. Crane
NEW YORK, July 22 (Reuters Breakingviews) - Detroit's
bankruptcy is doing bondholders a favor. The failed city wants
to include debt in its restructuring that the $3.7 trillion
municipal bond market considers sacrosanct. It's another example
of investors ignoring the limited options governments have to
honor their debts.
At issue are Detroit's general obligation (GO) bonds. This
type of commitment is most akin to sovereign debt, since the
government pledges to use its taxing power to pay back lenders
in full and on time. Many assumed that such a promise gave GO
bonds a stronger claim on assets than run-of-the-mill unsecured
debt, including pension and other retirement obligations.
Detroit begs to differ. Its emergency manager, Kevyn Orr,
who is charged with cleaning up the Motor City's fiscal mess,
proposes to lump GO bondholders in with retired civil servants
who are owed 17 times more.
Understandably, investors aren't happy about being thrust
into a Battle Royale with retirees. The bonds aren't actively
traded, but they took a hit when Detroit filed. The GO bonds
that don't come with insurance have now plummeted 55 percent
since May, according to Markit, the month before Orr presented
creditors with his restructuring proposal.
The matter is far from settled. It’s not even certain
Detroit can legally file for bankruptcy. But in light of
Greece's default, the downgrade of America's credit rating and
the disappearance of top-rated AAA sovereign issuers overall,
the controversy surrounding what are supposed to be the muni
market's most revered bonds should serve as another wake-up call
to investors. Previous notions of safety no longer apply.
Still, it’s never easy to cast aside assumptions before they
have been shattered. Just ask investors who bought subprime
mortgages confident that U.S. home prices would never go down,
or holders of Greek debt convinced that no euro zone member
would ever be permitted to default.
A pledge by a government to raise taxes to honor its debts
may seem like a safe bet. Often, it is. But Detroit's finances
have been suffering for years – and its tax rates are already at
or near statutory limits. Moreover, other cities and
municipalities are still struggling in the aftermath of the 2008
crisis. The sooner bondholders focus on the underlying credit
risk, and ignore outmoded notions of safety, the better.
SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS:
- On July 19, Fitch Ratings warned that investors in
Detroit's general obligation bonds may not be paid back on time
or in full despite the government's pledge to use tax revenue to
service the debt. The city, which filed for bankruptcy on July
18, is due to make an interest payment on the bonds on Oct. 1.
All in, Detroit has $18.5 billion in liabilities, including
- Detroit's emergency manager, Kevyn Orr, considers $530
million of Detroit's $1 billion of general obligation bonds as
well as pension and other retirement obligations to be unsecured
- Fitch press release: link.reuters.com/fev79t
- Federal judge sets first hearing in Detroit bankruptcy
Think big [ID:nL1N0FP0NS]
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More wealth, please [ID:nL2N0EU0OD]
(The author is a Reuters Breakingviews columnist. The
opinions expressed are her own.)
- For previous columns by the author, Reuters customers can
click on [CRANE/]
(Editing by Antony Currie and Martin Langfield)
Keywords: BREAKINGVIEWS DETROIT/BONDS
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