“In our nation, we join together in the promise and in the ideal
of a much grander bargain. It is the bargain by which we interact with each
other and with our government, all for the common good. That grander bargain,
enshrined in our Constitution, is democracy. It is time to restore democracy to
the people of the City of Detroit. I urge you to participate in it. And I hope
that you will soon realize its full potential.”
-Steven
Rhodes, U.S. Bankruptcy Judge, Oral
Opinion on the Record, In re City of Detroit, 7 November 2014 DOC
Federal Judge Steven
Rhodes ARTICLE delivered his ruling in the bankruptcy case for the City of Detroit on 7
November 2014. Due to the size and complexity of this Chapter 9 municipal
bankruptcy, the case and its ruling well may stand as a landmark example in the
fields of Law and Economics.
In this column, we review the oral opinion
presented by Judge Rhodes. After taking an overall walk-through of his
published document, we discuss the structure, conduct, and performance of the
many litigants from both sides as well as the aspects that led to the ruling
and to a plan that the Court considers to be “reasonable, fair, and equitable,”
as Rhodes describes it.
Next, we take a deeper look at the Grand Bargain that
is the fulcrum in this case and that gives the City of Detroit the ability to
move ahead.
An Open Discussion
(The following review of the Court ruling grew
from a discussion in a seminar that was held at Wayne State University on 10
November 2014. This seminar took place in my (Dr. Sase’s) course on Urban
Economics. The dialogue was among graduate students, undergraduate seniors, and
myself. These students (A. Bilotta, S. Berkirane, T. Eland, S. Guillot, J.
Hamade, J. Hinton, R. Justewicz, L. Moore, J. Palazzolo, J. Roy, B. Singh, and
K. Syed) and I hope that this short synopsis will clarify matters as well as
provide economic insight to the case and its resolution.)
In our
discussion, we relied upon Oral Opinion
on the Record, In re City of Detroit, a document issued by Judge Steven Rhodes
on 7 November 2014 in respect to Case 13-53846 filed on 18 July 2013 in United
States Bankruptcy Court, Eastern District of Michigan.
Within this forty-eight page document, the first twenty and the last five pages
encapsulate the issues, the arguments on both sides, the settlements upon which
both sides agreed, and the ruling of the Court. The remaining pages contain a
discussion of deeper legal issues that have arisen, including challenges to the
Constitution of the State of Michigan.
Since the discussion by my students and
I was held in an Economics seminar, our current article focuses on issues that are
addressed from an economic standpoint.
The core element
of the bankruptcy resolution and the subsequent plan for the revitalization of
Detroit has come to be known as the Grand Bargain. This ruling also includes a
number of peripheral though important elements that comprise the total $18
million settlement.
Throughout his discussion, Rhodes supports the opinion of
the Court by citing the numerous factions that have come together in this Grand
Bargain. Through compromise solution, the class representatives have negotiated
settlement agreements. In turn, each committee has taken its agreement to a
constituency that approved it by majority vote.
In his detailed narrative, Judge Rhodes
discusses the claims, the settlements reached, and the alternatives if these
settlements do not hold. These elements of the case coalesce in the Grand Bargain
and in the plan for revitalization.
In respect to the issues involved in each separate
class, Rhodes repeatedly comments that taking any decision by the District
Court to appeal would entail a process that would take many years to complete,
that would be expensive to litigate, and that would have a medium-to-low
probability of winning on appeal.
(For more on the process of conditional
probability used in this third point, see our article “The Economics of Law: The Expected Value of a Case,” ARTICLE).
While addressing each
individual class-settlement, Judge Rhodes underscores the fact that the
majority in each class voted to approve their respective settlements.
The Grand Bargain
The settlements
represented in the Grand Bargain ARTICLE include 1) The Pension Settlement, 2) The
Annuity Savings Fund Settlement, 3) The State Contribution Agreement, and 4)
The Detroit Institute of Arts (DIA) Settlement.
In summary, the major components of the Grand Bargain--the cornerstone
of the revitalization plan—are as follows:
1)
ThThe
Court allows the Unfunded Accrued Actuarial Liability (UAAL) of $3.1 billion to
be divided between the Police and Fire Retirement System (PFRS) and the General
Retirement System (GRS). Through mid-2023, the Federal Court interest rate of
6.75% will be used as both the Assumed Investment Return Rate for determining
the Future Value of assets and as the discount rate for determining the Present
Value of liabilities within the pension plans.
As of 1 July 2014, active
employees will receive benefits under new hybrid pension plans. Receiving an
Adjusted Pension Amount, FBRS retirees will experience no reduction in their accrued
pensions, though their future cost-of-living adjustment (COLA) will be reduced
by 45%. GRS retirees will experience a 4.5% reduction in accrued benefits and will
get no COLA.
ThThe planned funding-target for each system reaches 100% within
forty years. The Court estimates a 25% probability of success for pension creditors
taking their claim to appeal. However, the PFRS has accepted the plan through a
majority vote of 82%. The GRS did likewise with a vote of 73%.
2)
ThThe
Annuity Savings Fund Settlement connects to the pension settlement. The City has
claimed that the GRS increased its unfunded liability by over-crediting the
interest earned for each participant in the voluntary Annuity Savings Fund.
or
For many years, the GRS credited the fund at an assumed rate of return, even when
the actual rate was the lesser of the two. The City and the GRS have reached a mid-point
net settlement in the amount of $190 million.
ThThe Court estimates a 60% to 70%
probability of success on appeal, though the length, complexity, expense of
litigation, and issues of collectability could be substantial. However, the GRS
claimants have accepted the settlement by a vote of 73%.
3) The
State Contribution Agreement settles the matter of potential liability on the
part of the State of Michigan for the underfunding of both the PFRS and the GRS
under the Pension Non-Impairment Provision in the State Constitution (Article
IX, Section 24). Per the Agreement, the State must contribute $194.8 million,
immediately.
ThThe pension claimants will cease litigation and will release the
State and its related entities from liability. The Court states that the
novelty and lack of precedence of this case make the determination of the
probability for success on appeal challenging.
Al Also, the Court hammers the point that any such litigation would be long,
complex, and expensive. Nevertheless, the parties have settled, with the
representatives of the pension claimants concluding that the contribution by
the State is fair.
ThThese pension claimants have returned a vote that strongly
supports the contribution agreement and the release of potential claims.
4)
WiWithin this Grand Bargain, a number of
large financial components have been brought to task by a major core of groups
and individuals. These include the Attorney General of the State of Michigan,
the Detroit Institute of Arts, the Police and Fire Retirement System, and the
General Retirement System, as well as nine private foundations and a number of
creditors from the private sector.
TTThroughout this case, the strongest light
has been focused on the assets of the Detroit Institute of Arts (DIA) and the
restrictions involved with transferring any part of the collection. Within this
action, appraised values have risen higher than $8 billion. How these assets
are being handled is creating a precedent in Federal Case Law.
One major
creditor, the bond-insurer Financial Guaranty Insurance Company (FGIC), called
for the DIA to sell its artwork. At the very least, the FGIC wanted the City to
monetize the artwork in the form of loan collateral in order to borrow funds to
pay off the FGIC.
To support its claim, the insurer retained Victor Weiner
Associates of New York WEB, which came in with a high-end valuation of $8.5 billion
for the full collection of 60,377 pieces. However, Artvest Partners, LLC WEB has
determined a maximum value of $4.6 billion while noting that, in a liquidation auction,
the net proceeds would come in at $1.1 billion.
In response, Emergency Manager
Kevyn Orr ARTICLE has stated that this would not constitute a viable path. Furthermore,
millage taxes currently help to support the DIA by providing $23 million per
year to the DIA Total Operating Budget of $28.4 million.
If the artwork were to
be sold, the DIA could expect to lose 81% of its annual revenue.
In
response to the crisis that has brewed around these art assets, a number of
parties have come together to create the Grand Bargain. As the critical financial
issue revolves around pensions and related benefits, the DIA has pledged $100
million to the pension funds. The State of Michigan has pledged $350 million to
these funds, while nine foundations have pledged $330 million.
The
Detroit Institute of Arts Settlement ARTICLE has evolved through a consortium of the
State of Michigan and nine charitable foundations, including the Ford, the Kresge,
and the John S. and James L. Knight.
As
a result, the DIA will secure and guarantee commitments for contributions to
the PFRS and the GRS at an average of $5 million per year over twenty years
($100 million). Furthermore, the charitable foundations will contribute an average
of $18.3 million per year for the same duration ($366 million).
The City will
transfer the art collection of the Institute to The Detroit Institute of Arts Corporation, a
not-for-profit that operates the DIA and that will hold the art in a perpetual
charitable trust ARTICLE.
The Court states that historical-documentary evidence
supports two major assertions made by the State and the DIA. The DIA asserts
that the donors of many of the artworks imposed specific transfer restrictions
upon these works at the time of donation.
Furthermore, both the DIA and Bill Schuette, the
Attorney General of Michigan, take the position that the art is subject to a
trust that prohibits the City from selling it to pay debts.
Though creditors
submitted substantial evidence and legal grounds to the contrary, the Court
concluded that a vigorous contestation by the Attorney General and the DIA
almost certainly would prevail in litigation that could take years to achieve
and be costly to pursue.
Furthermore, the Court cites the existence of credible
evidence that any attempt to sell the artwork by the City, which currently is
the owner of record, may result in a loss of more than two-thirds of the
operating revenue of the DIA. This would be due to the cancellation of millage
taxes from Wayne, Oakland, and Macomb Counties.
The
Other Important Issues
The
preceding four components of the Grand Bargain represent the critical ones for
the satisfactory conclusion of this action and for Detroit moving forward toward
revitalization. However, the Detroit Bankruptcy Case includes a number of other
settlements as well.
Before concluding, let us mention a few of these elements:
The issue involving other post-employment benefits for retirees, including
health care and life insurance (OPEB), has settled at a midpoint compromise of
$4.3 billion.
The bond insurers that paid default claims on Unlimited Tax
General Obligation bonds (UTGO) claimed a lien on the revenue stream of City
property taxes. However, they settled their claim for $388 million.
Syncora
Guarantee had several disputes with the City. Their agreement brought $45
million to Syncora in the form of new debt instruments as well as a five-year
property development concession and the joint assumption of the Detroit-Windsor
Tunnel lease until 2040.
“The Grand Plan”
In the attainment
of the Grand Bargain and the subsequent plan for revitalization, many groups
have come together to create a structure that was built upon a series of
individual class settlements. The representative committees achieved this
through conduct that allowed for settlement agreements to materialize through give-and-take
negotiations.
The various classes performed well by voting to approve the
respective settlements that were brought forth by their representatives. Judge
Rhodes delivered a ruling on the ensemble of agreements that were reached.
Given
that this bargain is a mousse that has not quite set, he transparently warned
the key players that any efforts that could jeopardize the Grand Bargain would
result in a long and expensive scenario that has a low probability of surviving
the appeal process.
For this plan to work, then, all of the components must be
in harmony. As an economist, I (Dr. Sase) agree that this Grand Bargain crafted
by the Court is “reasonable, fair, and equitable.”
Though in need of
fine-tuning, the resulting plan for revitalization can work economically. The
bargains are sound, the dollar amounts are reasonable (given the situation),
and the long-run projections are attainable, with a little bit of luck.
Let us
hope that clear heads will prevail as to not jeopardize our mousse during this
period of fragility.
We hope that our synopsis has aided the understanding of
this important case and the underscores the precedence that it sets in the
fields of Law and Economics.
For our readership, we hope that we have offered a
concise and clear treatment that will assist everyone in further explaining the
outcome and potential future of the City of Detroit to colleagues, clients, and
the community at large.
