Friday, January 31, 2014

Detroit Bankruptcy

 "Negotiating with (a US Political Figure) is like playing chess with a pigeon. The pigeon knocks over all the pieces, craps on the board, then struts around like it won the game." -Russian President Vladimir Putin 

Law is based on the identification and application of suitable precedent.  Reference to precedent provides stability and predictability.  Stability and predictability are the foundation of trust.  Trust is why people willingly invest their blood, sweat, tears and dollars into financial vehicles like bonds.  The alternative to investing money is to spend it now.

Case law and the U.S. Bankruptcy Code both hold that debt holders (banks and bonds) shall be given a higher priority than unpaid wages and contributions to benefit plans.

That is not how the cards are playing out in the Detroit bankruptcy.

Adolescent Economic Thinking

Kubota  is fourteen so he can be forgiven for having some unsophisticated, economic thinking.  He expressed his outrage over sales taxes.  He thought it was total BS that the governor of Michigan took his money when the governor could just print more.

I did not laugh because I have heard 60 year old ex-hippies at soccer games loudly proclaiming the same thing.

I told him a little bit about the Wiemar Republic and what happens when governments go down that road.  I told that that the bottom line is that money's primary value is as a way of keeping track of claims on real assets.  And that there is no way of getting around the fact that somebody, somewhere must actually produce those assets.

One of the attributes of adolescent thinking is the inability to formulate the next logical question. As in, "If you did that, then what else is likely to happen as a consequence."

Political Economic Thinking

The "smart money" was expecting that non-secured creditors would get about twenty cents on the dollar out of the Detroit Bankruptcy.

There was some breakfast table discussion, fear really, that the GM/Chrysler bankruptcies would be the template for the Detroit Bankruptcy.  In those bankruptcies, the employee benefits were leapfrogged ahead of the debt holders in violation of the U.S. Bankruptcy Code.  Unionized employees were "made whole" while debt holders received nothing.

It now appears that those fears were well founded.

The Next Logical Question

Why would any investor seeking a safe haven for his/her assets ever buy another municipal bond?  Why would any entity with a legally defined fiduciary responsibility ever buy another municipal bond.  Or for that matter, why would they ever buy a bond in any industry with unionized labor?

OK, I engaged in a little bit of hyperbole.  You could get me to lay down on the railroad track IF you offered a sufficient monetary premium .and. there was no train within 100 miles.  But that term "sufficient monetary premium" will destroy governmental operating budgets.  They cannot afford to roll over low interest bonds as they mature by issuing new bonds...with substantially higher interest rates.  Issuing those higher interest bonds would bump up the risk of default.  In our analogy, the railroad tracks would be a-rumbling as Ol' # 99 came around the bend.

Two Endgames

One endgame is for municipalities to swear fealty to the Federal Government and to get out of the bond issuing business.  There are people who think this is a dandy idea.  After all, the Federal Government can just print some more money, right?

The other endgame is for administrators to hang on to their autonomy and to try to thread the needle.  Population bases continue to erode.  External regulations continue to be imposed.  In some cases, the low level administrators are also unionized and struggle to balance their duties to manage efficiently and their union solidarity.  They become unable to issue bonds.  Then they get dragged into bankruptcy by their own employees to pre-empt favorable treatment before contracts can be re-opened.

Reading the Tea Leaves

Sometimes the best one can manage is to fail heroically.  Like the Alamo.

Most administrators will not hand their cities over to the Feds.  They will battle heroically to keep them out of the ditch.  In many cases, they have already gone past the point of no return.

Detroit employees and pensioners will get between thirty-and-forty cents on the dollar.  Bond holders will get between zero-and-ten cents on the dollar.

Municipal bonds will lose their low risk, tax deferred luster in the investment community.  Borrowing costs will go up for every governmental unit.

A fire storm of bankruptcies will sweep across the nation, hitting California and the Rust Belt first.  Then the Northeast corridor.

The Feds will make a strong case for a FEMA type administration to fast-track the handling of these cities but they will be blind sided by rising interest rates.  Inflation will also occur because people will lose the trust needed to plow their money into investments.  Rather, they will indulge in instant gratification.  Rising interest rates will accelerate because of a general loss of trust in the dollar as a store of wealth as inflation becomes too big to kick beneath the carpet.

I don't play chess very well, but I play it better than a pigeon.

1 comment:

  1. You may have missed the one saving grace. Interest rates will not go up and investment bankers will still buy city bonds at standard rates.
    Obama will order it so. They will be ordered to lose money.
    We have been ordered to buy government mandated cars, light blubs and health insurance. With smart meters and shut off switches on every car, our energy usage will be controled.
    Don't worry. Liberal cities and unions will be allowed to flurish until the bitter end. At the end of course they will be marched off to the labor camps, but that is for another post.