Why did the pension recipients, many of whose pensions were cut by 55%, not object to this special protection for [the] bonds? The acquiescence appears to be explained by a key feature of Central Falls’ general obligation bonds. Nearly all of the money used for the bond payments comes from Rhode Island itself, rather than from Central Falls. As a result, restructuring the bonds would not have freed up any additional value to pay pension recipients and other Central Falls creditors. (Emphasis added.)
25 September 2014
Those who read my article, Municipal Bankruptcy: When Doing Less Is Doing Best (download here) may have joined in my wonderment at why the pensioners of the small Rhode Island city of Central Falls didn't balk at the state-enable grab of the city's future income by bondholders. Now we know the answer. But first, some background.
Central Falls was a clearly insolvent city and was permitted to file for a Chapter 9 municipal bankruptcy under Rhode Island law. Based on the the analysis of the Bankruptcy Code that I describe in the article, both the city's retired workers and bondholders should have received payment of an equal percentage of their claims. Both were unsecured in the sense that neither retirees nor bondholders had a lien on any of the city's assets. But that's not what happened.
Shortly before Central Falls filed bankruptcy, the Rhode Island legislature passed a law providing that all previously unsecured bond payments were immediately secured by all of a city's general revenue. In other words, the bondholders would be paid in full and the retirees--and other general creditors--would be left to share in the leftovers. A sweet deal to say the least.
Download and read Professor David Skeel's latest piece, What's A Lien? Lessons From Municipal Bankruptcy (download here). Among many interesting conclusions, David explains why the shafted retirees voted in favor of the city's plan that implemented the last-minute grab by the bondholders. The retirees may not have had any legal grounds to object to the plan of Central Falls but that doesn't mean they had to roll over and vote for it. Voting against the plan would have forced the city to resort to "cramdown," which is a tougher row to hoe on the way to confirmation, and might have been a way to squeeze at least some concessions from the bondholders.
So why didn't the retirees vote no? As David asks and answers,
One of life's little mysteries solved. Of course, one might now wonder how it came to be that Rhode Island pays the bond debt of its cities but the answer to that question must wait to another day.
David's paper addresses a number of other interesting questions including why the repo safe harbors should be repealed (for a short explanation of repos read my A Fable of Financial Contracts: A Guide for the Perplexed (download here)) and how Detroit (and likely Stockton as well) can legitimately restructure pension obligations in the face of state law and state constitutional protections. Well worth the time to get a handle on issues currently roiling municipal bankruptcy law.