Ripple effect
Detroit seems a long way from the Old Dominion, and its bankruptcy woes seem largely irrelevant to a state and its local governments which, whatever else their flaws, have among the strongest bond ratings in the country. But it would be a mistake for Virginians to ignore events in the Wolverine State.
It looks like holders of Detroit municipal bonds will take a proverbial hair cut. That’s inevitable, and even understandable as the city’s emergency manager, Kevyn Orr, fights to shore up basic services for city residents. If that means taking on the public employee unions and the bond holders, he’s willing to do it. And public opinion will be on his side. The unions have been guilty of gross over-reach and bond holders, for the most part, are big boys who understood the risks they were taking when they bought the bonds.
But precedents could be set that could rattle municipal bond markets. As the Wall Street Journal reports today, “A fight over bankrupt Detroit’s sewer system threatens to reshape the nation’s $3.7 trillion municipal bond market.”
Owners of some $5 billion in water-sewer bonds thought they were well protected because their bonds were backed by revenues from Detroit’s water-sewer system, which is solvent. Orr wants to renegotiate the terms of the bond deal in order to free up water-sewer revenue for other city needs.
Bond holders are spooked, even though Orr maintains payments on the water-sewer bonds will be secure. Credit-rating firm Standard & Poor’s declared that Orr’s plan “tantamount to a default” on the bonds. “You really break the foundation” of debt markets if municipalities can freely restructure their obligations, Jim Colby, a muni strategist for Van Eck Global, told the Journal.
The legal structure backing municipal bonds will come under increasing stress as Detroit and other bankrupt cities resort to increasingly desperate maneuvers to stay afloat. It’s not clear such actions will have on states, like Virginia, that have gone to great lengths to preserve their credit ratings. Will such shenanigans sour investors on the entire class of municipal bonds, a bad thing for Virginia? Or will they engage in a flight to quality, which could be a good thing for Virginia? That depends largely upon the rulings of Detroit judges. But Virginians should pay attention — we have a lot riding on the outcome, too.
Update: The WSJ has a follow-up story today on Saginaw County’s decision to postpone a $60 million bond offering, following decisions by Genessee County and Battle Creek to pull bond sales last week. Clearly, the contagion is spreading throughout Michigan. The question is, will it spill beyond Michigan’s borders.
— JAB
