The Other Shoe Drops

Detroit, former motor powerhouse, filed Chapter 9 bankruptcy today. Chapter 9 is a provision of US bankruptcy law that allows municipalities to file; filings have been rare. However, Detroit will be the largest in Ch 9’s history, after Jefferson Co. Alabama. Detroit joins Stockton, CA, which is currently working under Ch 9, sorting out who owes who how much via the court system.

The interesting thing about Ch 9 is that the law is written in the court system, bit by bit, locale by locale. So unlike the tried and tested Chapters 7 and 11, where law is well understood and relatively standardized, Ch 9 takes on the flavor of the individual locale’s concerns, such as whether retirees can step in front of bondholders, or not.

This case is an attention-grabber for any municipal bond investor – or should be. Its outcome will affect the market for some time. If unsecured general obligation debt holders are forced to take a big haircut, it will be one more nail in the coffin of the naive bond investor. As Kevyn Orr, Detroit’s emergency manager, warned some time ago, any investor in Detroit’s bonds should have well understood what was happening from about five years back, as this situation has been well-broadcast for some time. Buyer beware.