Detroit creditors ponder bankruptcy as preferred option

When New York City threatened to declare bankruptcy in 1975, the idea so terrified everyone that it forced the city, its workers and its recalcitrant bankers to sit down and find ways to share the pain.

Now Detroit appears to be on the brink of filing for bankruptcy, but there is little talk of sharing the pain. Instead, the crisis in Michigan is building as a gigantic clash between bondholders and city retirees.

The city's proposals, which could give some bondholders as little as 10¢ on the dollar, are making some creditors think they would be better off in bankruptcy.

"The haircut is so severe," said Matt Fabian, a managing director of Municipal Market Advisors, "I think it's scaring them into bankruptcy, rather than away from bankruptcy."

But city retirees, facing the prospect of sharply reduced benefits whether in bankruptcy or under Detroit's restructuring proposal, think they stand squarely on the moral high ground because despite the poverty of many current and retired members, they have already offered big concessions.

With talks on labour issues scheduled for Thursday, municipal bond market participants say one of their main concerns is the city's proposal would flatten the traditional hierarchy of creditors, putting say, a retired librarian on par with an investor holding a general obligation bond. That does not square with the laws and conventions of the municipal bond market, where for decades small investors have been told such bonds are among the safest investments and that for "general obligation" bonds cities could even be compelled to raise taxes, if that was required. The "full faith and credit" pledge was supposed to make such bonds stronger than the other main type of muni - revenue bonds, which promised to pay investors out of road tolls or other project revenue.

Public finance experts have warned that broad societal problems could follow a loss of faith in municipalities' commitments to honour their pledges. Last year, the Securities and Exchange Commission warned communities would find it increasingly costly to raise money, threatening the time-honoured practices of building and financing public works locally.