Record-Breaking Detroit Bankruptcy Filing Worries Bond Investors

Detroit filed for Chapter 9 bankruptcy on Thursday, July 17, with an estimated $18.5 billion in debt, making it the largest municipal bankruptcy in U.S. history. Experts anticipate that bondholders will suffer significant losses. Some Detroit bond prices, as well as municipal-bond prices overall, fell Friday morning, July 18. Bond investors are concerned with Detroit’s apparent effort to make significant cuts on general-obligation bonds, which are backed by a municipality’s taxing authority, and traditionally seen as one of the safest types of municipal bonds.

“Michigan has been touted for years as one of the most bond-friendly states out there,” said Robert Miller, senior portfolio manager at Wells Capital Management, which oversees $32 billion in municipal bonds, reported the The Wall Street Journal. “That reputation is shot.”

Michigan Gov. Rick Snyder authorized the bankruptcy filing at the urging of the city’s Emergency Manager, Kevyn Orr. “The fiscal realities confronting Detroit have been ignored for too long. I’m making this tough decision so the people of Detroit will have the basic services they deserve and so we can start to put Detroit on a solid financial footing that will allow it to grow and prosper in the future,” said Michigan Gov. Rick Snyder, according to USA Today. “This is a difficult step, but the only viable option to address a problem that has been six decades in the making.”

Detroit is the largest municipal bankruptcy in U.S. history. New York, Cleveland and Philadelphia previously veered towards bankruptcy, but Detroit is the first major U.S. city to take the plunge. Prior to Detroit’s bankruptcy filing, the largest municipal bankruptcy was filed by Jefferson County, Alabama in November 2011 with $4.2 billion in debt, according to Reuters. Also notable, was the 1994 bankruptcy filing of Orange County, California with $1.7 billion in debt.

Experts anticipate that there may be additional bankruptcy filings by counties, cities, and towns who must face rising costs while grappling with economic recession. Prior to Detroit’s filing, there had been four Chapter 9 municipal bankruptcy filings so far this year, compared with 12 in 2012 and 13 in 2011, according to James Spiotto, partner at Chapman and Cutler LLP, reported Reuters.

Chicago also faced negative financial news this week. Moody’s dropped its quality assessment of Chicago’s general obligation bond debt by three levels, from Aa3 or what is considered the lower end of “high grade, high quality” to A3, which is at the lower end of what is considered to be “upper medium grade.” Moody’s also found that the future of Chicago’s fiscal outlook was “negative.” In so doing, Moody’s cited pressing public safety demands, an unwillingness to raise taxes, and substantial pension obligations, including pension contributions which the city has been unable to meet. The ratings downgrade can limit Chicago’s access to future credit and increase loan costs, which adversely impacts funding.

“There’s no way to sugarcoat this,” said Brian Battle, director at Chicago-based Performance Trust Capital Partners, an investment adviser specializing in fixed-income products, reported The Chicago Tribune. “This is bad for Chicago.”

Prior to the downgrade, Chicago’s credit rating was only one slot below that of New York and Los Angeles. Chicago now trails not only those two major metropolises, but also other large Midwest cities, including Milwaukee and Cleveland.

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