A Bit More Detroit News

Moody's reports here today that Governor Snyder's announcement this past week that he plans to appoint an emergency financial administrator for Detroit may lead to a Chapter 9 bankruptcy. Only what I've said here and here. Moody's, not surprisingly, casts such an event as troubling for bondholders. But the article goes on to suggest why I don't think bondholders are at great risk, at least some of them: interest rate swaps. (If the term interest rate swaps mystifies you, you might want to look at my latest published piece, A Fable of Financial Contracts: A Guide for the Perplexed (abstract here). It's a short (3 page) article published in a professional journal so it's not as lay "unfriendly" as my more academic stuff.)

If the counter-parties to Detroit's interest rate swaps have not deemed previous reductions in bond ratings sufficient to justify requesting termination payments, the same will probably hold if Detroit files Chapter 9. Why, you might ask, hasn't Detroit's deteriorating financing situation led to calls for payouts by swap counter-parties? Because "its swap payments, ... are supported by an intercept of the city's share of casino revenue distributions from the state." In other words, Detroit is operating subject to a standing wage garnishment. That should survive bankruptcy, which means that bondholders should come out okay.

But the same cannot be said for retirees or, for that matter, current employees and, most of all, current taxpayers. The hit--and the hurt--will land somewhere if Detroit goes the Chapter 9 route.