Pensions vs. Art in Detroit’s Bankruptcy

 

The objection deadline has arrived for Detroit’s reorganization plan. And it seems likely that the “art deal” will be the focus of many objections, especially from bondholders.

 

The art deal involves an $816 million cash infusion into Detroit’s pensions in exchange for transferring title to the works in the Detroit Institute of Arts, using $370 million from a group of foundations, $350 million from the state and the museum’s own money. It’s basically a sale of the art, in exchange for money to help avoid deeper cuts to the pensions, which are underfunded by $3.5 billion.

 

The sticking point is that Detroit’s bondholders are a bit sore that they won’t receive the same deal. Municipal retirees are facing cuts of 4.5 percent in their pension checks, while retired police officers and firefighters are facing no cuts, though their cost-of-living increases would be diminished. But certain general bondholders face about a one-fourth cut in the value of their bonds. Other bondholders, including those with claims on specific income streams, are coming out even worse.

 

These latter bondholders can be expected to argue that Detroit’s plan to exit bankruptcy “unfairly discriminates” against them. Chapter 9 incorporates this concept from the better known Chapter 11: the court cannot approve a plan against the will of the creditors if it discriminates unfairly. Giving a much better deal to one group over another could be an example of that. One bond insurer insists that creditors are entitled to the value of the art and is asking Detroit’s bankruptcy judge, Steven Rhodes, to order the city to explore alternatives to the $816 million deal.

 

After all, pensions and bonds are just two different kinds of unsecured claims when viewed with a certain degree of abstraction.

 

But when viewed with a bit of reality, they are, of course, quite different.

 

There is no way to liquidate a city. And if the bondholders and other creditors want to recover anything from Detroit, they need to make sure that it does not become a completely failed city.

 

Future revenues are important, but if nobody will work for the city because it reneged on its promises and the quality of life deteriorates even more than it already has, no one will want to live there. Revenues don’t come from a vacant lot.

 

If nobody will live in Detroit, its assets will have no value to the creditors. This means that there are good reasons to treat workers differently from bondholders. Detroit needs workers to rebuild the city.

 

This actually works with both sides of the art deal: If Detroit is stripped of its art, and its employees are unhappy, its chances of regaining viability drop tremendously.

 

In short, it may be discrimination, but it’s not unfair.