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Careful what you wish for (”Bankruptcy Edition”)

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An attempt by holders of bonds issued by bankrupt San Bernardino to win the same treatment accorded the city’s biggest creditor, state pension giant Calpers, was rejected by a federal judge on Monday, in a ruling the judge called “tentative.”

The ruling comes three days before the southern California city of San Bernardino produces its bankruptcy exit plan, which, if confirmed, would appear to clear the way for the city to slash its bondholder debt. The city has already said that it intends to pay Calpers, which has assets of $300 billion, in full.

The ruling mirrors what happened in two other recent city bankruptcies - Detroit Michigan, and Stockton, California - where bondholders were paid little of what they were owed, while pensioners and pension funds emerged relatively untouched.

[Hat tip: News Alert]

posted by Rich Miller
Tuesday, May 12, 15 @ 9:35 am

Comments

Kind of blows a hole in the theory of busting unions by allowing muni bankruptcy.

Comment by Wordslinger Tuesday, May 12, 15 @ 9:40 am
It’s simply not fair to “Pick and choose” who gets paid and who doesn’t based on politics and self serving government bureaucracy. A decent judge would ensure that ALL bondholders are treated with equal protection under the law, but I guess “California justice” is more equal for some than others…

Comment by Arizona Bob Tuesday, May 12, 15 @ 9:40 am
Thanks, Rich. I fail to understand why the Civic Committee and the Trib don’t get this.

The Civic Cimmittee has a couple of real lawyers on it. Can’t they explain this to Ty and the others?

Comment by Anonymous Tuesday, May 12, 15 @ 9:40 am
I think the Owl Sandack’s plan is laying eggs without “Don” even paying attention.

Mayor Sandack was right…

Comment by Oswego Willy Tuesday, May 12, 15 @ 9:45 am
The Detroit BR judge was appointed by Bush and Detroit is not in California

Comment by Illinois Manufacturer Tuesday, May 12, 15 @ 9:45 am
Decent judges care about people who depend on their pensions rather than wealthy investors who may have to forgo purchasing their 10th mansion.

Comment by Norseman Tuesday, May 12, 15 @ 9:46 am
It was because we had the security of my wifes pension I was able to repurchase my old struggling family business and keep it in this state. Think about that AZ Bob and you other dopes

Comment by Illinois Manufacturer Tuesday, May 12, 15 @ 9:49 am
az bob if you think that judge’s decision was based on politics and self serving beauracracy, whatever that means, then you know nothing about how the bankruptcy court system works

Comment by erik Tuesday, May 12, 15 @ 9:53 am
As a conservative I have to warn anyone considering themselves either conservative or libertarian of thinking that bankruptcy is a viable option. It is a bad deal.

It is important that folks who favor a sustainable government which doesn’t crowd out private enterprise, to honor contract laws, unions and constitutions.

Any governor favoring bankruptcy and disunion for the states they govern need to be replaced. These advocates for chaos have no place holding any elected position as important as governor. Governors are to be depended upon to keep us together and keep the faith, not rip us apart.

Comment by VanillaMan Tuesday, May 12, 15 @ 9:54 am
Pension obligations trump bond holders. Seems the best option is to deal with the pension debt if at all possible. The bankruptcy option is unfavorable to the municipal bond market - and will be a bigger mill stone for the future than the pension debt is now.

Comment by archimedes Tuesday, May 12, 15 @ 9:54 am
It’s simply not fair to “Pick and choose” who gets paid and who doesn’t based on politics and self serving government bureaucracy.

Who said anything about fairness? If you want to avoid namby-pamby judicial decisions - don’t rely upon them to kick retirees into poverty so you can get your bankroll back. Politics has got nothing to do with it. Its called basic humanity.

Comment by VanillaMan Tuesday, May 12, 15 @ 9:59 am
Of course, here in Illinois, this result would be constitutionally mandated.

Comment by jrusslaw Tuesday, May 12, 15 @ 10:02 am
So labor unions should encourage bankruptcy?

Comment by Kimly Tuesday, May 12, 15 @ 10:05 am
“It’s simply not fair to “Pick and choose” who gets paid and who doesn’t based on politics and self serving government bureaucracy.”

Who said anything about fairness?

Also, it’s a bit silly to assert that bond holders and the executive branch agency that manages public employee and retiree pension and health benefits are identically situated under the law.

– MrJM

Comment by MrJM Tuesday, May 12, 15 @ 10:05 am
==It’s simply not fair to “Pick and choose” who gets paid and who doesn’t based on politics and self serving government bureaucracy==

==A decent judge==

Isn’t it funny Bob that anything you disagree with is political or the work of a bad judge. I doubt you would have been making the same statement had the judge ruled in favor of the bond holders.

And what would your plan have been Bob? Bankruptcy isn’t fair Bob. Those that advocate for it should think about that for a while.

Comment by Anonymous Tuesday, May 12, 15 @ 10:06 am
That was me above

Comment by Demoralized Tuesday, May 12, 15 @ 10:06 am
==Also, it’s a bit silly to assert that bond holders and the executive branch agency that manages public employee and retiree pension and health benefits are identically situated under the law.==

Don’t confuse Bob with the law.

Comment by Demoralized Tuesday, May 12, 15 @ 10:07 am
“It’s simply not fair”- because the judge didn’t stick it to the people you wanted him/her to. Dope.

Comment by JS Mill Tuesday, May 12, 15 @ 10:17 am
Bankruptcy Court is like the Mad Max: Thunderdome version of the wheel of fortune. You don’t know what you are going to get, but you know it is going to hurt like crazy.

Comment by SAP Tuesday, May 12, 15 @ 10:23 am
How about we allow cities to issue bonds to fund their pension systems (police and fire mostly, and all systems for Chicago/Cook). And then after a little time passes, allow them to declare bankruptcy, and short the bondholders. The pension systems will be funded, no retirees would end up on the street. You couldn’t borrow for a while, but the State could rescind the bankruptcy statute to give future bondholders some comfort. (snark. I think…)

Comment by Salty Tuesday, May 12, 15 @ 10:33 am
Bond holders assume risk when they buy the bond. This is why they get interest for the use of their money. While pensioners have not been able to opt out of that risk since participation in the pension plan is generally a condition of employment. So these rulings are quite fair.

If I were a Chicago bond holder I would certainly be worried about Rauner’s suggestion for Chicago to declare bankruptcy.

Comment by A Jack Tuesday, May 12, 15 @ 10:36 am
==Decent judges care about people who depend on their pensions rather than wealthy investors who may have to forgo purchasing their 10th mansion. ==
In some cases wealthy investors don’t need to purchase their 10th mansion. Sometimes, the people unwittingly, give them the 10th one free.

Comment by Skeptical Tuesday, May 12, 15 @ 10:42 am
I find it interesting that in these cases (Chicago, Detroit, Stockton) bondholders are always the least likely to negotiate. Unlike public employees, these investors knew there was an element of risk. Anyway, anyone interested in the details of the Detroit bankruptcy should read this in-depth piece from the Detroit Free Press:

http://archive.freep.com/interactive/article/20130915/NEWS01/130801004/Detroit-Bankruptcy-history-1950-debt-pension-revenue

I thought the judge and the mediator there did a fantastic job.

Comment by Alex Tuesday, May 12, 15 @ 10:54 am
I think that pensioners should take a haircut although not as much as the bondholders. If you think the Detroit decision was unfair, look at what happens to pensions when a private company goes under.
w
hen a private company goes under.

Comment by john doe Tuesday, May 12, 15 @ 10:59 am
Sorry for the typos.

Comment by john doe Tuesday, May 12, 15 @ 11:00 am
ABob,
1) and bankruptcy judges are what?
2) do you believe rulings by bankruptcy judges are driven predominantly by local political considerations?
3) if so, why?

========= - Arizona Bob - Tuesday, May 12, 15 @ 9:40 am:

It’s simply not fair to “Pick and choose” who gets paid and who doesn’t based on politics and self serving government bureaucracy. A decent judge would ensure that ALL bondholders are treated with equal protection under the law, but I guess “California justice” is more equal for some than others…=========

Comment by zonz Tuesday, May 12, 15 @ 11:24 am
So the city schools could file bankruptcy and write off everyone but their pension… The. Get the lension fully funded….

Comment by Ghost Tuesday, May 12, 15 @ 11:31 am
Maybe someone should read this articles out loud at the next Cicago Tribune editorial board or IPI “harrumph ” sessions. Bankruptcy will hammer bond holders and spare pension recipients if this trend continues, hurting their biggest benefactors the most.

On second thought- shhhhhh…

Comment by Roadiepig Tuesday, May 12, 15 @ 11:35 am
Roadiepig, ironically, the funds that got caught holding the bag of controlling interest when Tribune Co. emerged from bankruptcy are largely invested pension funds.

Comment by Wordslinger Tuesday, May 12, 15 @ 11:41 am
Bob:

A plan that treats unequal creditors unequally is inherently unfair.

Oakland A’s owner Charlie Finley used to argue that he wasn’t a racist because he paid Reggie Jackson as much as any other outfielder.

Bankruptcy judges have to consider the impact that debt forbearance will have on a creditor. And the plan also has to lead to the municipality becoming financially stable again. Pulling the financial rug out from under your own residents creates a spiralling increase in costs for cities that would make your financial situation worse, not better.

Keep in mind, in both Stockton and Detroit the bankruptcy plans were crafted by Republicans.

And federal judges are not elected.

Other than that, your analysis was as spot on as usual, Bob.

Comment by Juvenal Tuesday, May 12, 15 @ 11:42 am
They don’t really want bankruptcy. It’s more that they think the unions and public employees will quake in their shoes at the prospect and bend over and give up all their salaries and benefits. Time to call the bluff.

Comment by anon Tuesday, May 12, 15 @ 12:04 pm
In addition, the bankruptcy code treats different creditors differently. This is inherent in the law. Employees are paid first, then trade creditors (landlords, utility companies, office suppliers, etc.). Then, the lenders and bondholders are repaid in an order that is usually determined when the debt is issued - lenders negotiate their seniority in bankruptcy at the time the loan is signed.

The status of corporate pensions in bankruptcy is determined by the Pension Benefit Guarantee Corporation, which takes over insolvent pensions. However, state and municipal pensions are not covered by PGBC, and they probably would not be nearly as generous as if they were. That political comment aside, the courts in Stockton and Detroit have made the pensions senior to other creditors. The creditors have not challenged that in court, either, which means that this is likely to be the guiding precedent if Illinois, the City of Chicago, or CPS were to file for bankruptcy.

Comment by AnonAdjunct Tuesday, May 12, 15 @ 12:08 pm
Anon,
Aren’t bonds secured debt, superior to the claims of trade creditors, who are unsecured?

I was trying to write something similar earlier, but couldn’t remember my business law clearly enough to hit “Say It!”

Comment by jerry 101 Tuesday, May 12, 15 @ 12:15 pm
Oh, and that comment from AnonAdjunct about the PBGC is probably a lot more important than some people realize. I would imagine that the PBGC guarantee causes courts to move pensions down the line in private sector bankruptcy cases, but the lack of PBGC protections probably fed into the decision by the courts to put pension seniority very high.

I also think, but don’t know, that different types of bonds inherently have different levels of seniority. I would think General Obligation debt is very senior and is unlikely to take much of a hair cut (GO debt is funded by tax revenue and is considered highly secure), while Revenue Bonds would be lower down the seniority line since they are less secure (tied to specific revenue streams, such as sewer billing, and if those sources don’t perform, well…c’est la vie).

Can anybody confirm my understanding?

Comment by jerry 101 Tuesday, May 12, 15 @ 12:19 pm
“I also think, but don’t know, that different types of bonds inherently have different levels of seniority. I would think General Obligation debt is very senior and is unlikely to take much of a hair cut (GO debt is funded by tax revenue and is considered highly secure), while Revenue Bonds would be lower down the seniority line since they are less secure (tied to specific revenue streams, such as sewer billing, and if those sources don’t perform, well…c’est la vie).”
—————-

That may be technically correct (in isolation), but that’s not how it’s been working in practice. It’s more of competing reorganization plans filed with the court, and then the process is the different parties presenting reorganization plans ‘adjust’ their plans accordingly to be the one selected by the court.

That’s where the sausage gets made. Obviously the bankruptcy judge does get to shape the process, and that’s when competing parties get to go over all debts (and assets) with a microscope, and that’s really why so much bonded indebtedness gets to take some serious haircuts.

And that’s why there are so many lawsuits still outstanding over what can only be called some pretty creative ‘financial engineering’. Interesting times ahead.

IMO (being a Contrarian), I’m more in favor of bankruptcy for local governments. There’s a lot of ’sweetheart’ financial deals out there, and those need to be curtailed. The regulators haven’t done it, because IMO, (a) they aren’t up to it knowledge wise, and (b) Regulatory ‘capture’ has occurred.

Hard truth is that bankruptcy for units of local government may not be a choice. May be an ‘option’ that we just can’t avoid having to utilize.

Here’s why: Currently, there appears to be an unanswered question out there for units of local government in bankruptcy. And it’s a biggie:

“Is the ability of a unit of local government to increase property tax revenues above current state law part of the ‘Asset’ class in a bankruptcy filing?”

Probably didn’t phrase it quite right, but simply put, can the bankruptcy court just allow such directives to increase local taxes regardless of state law as part of a selected reorganization plan?

IMO, that’s the issue right there……

It’s all about the numbers…

Comment by Judgment Day (on the road) Tuesday, May 12, 15 @ 1:00 pm
Those of you who assume those bonds are held by ‘wealthy investors” obviously know nothing about bond funds and ownership. Does who holds the bonds make a difference in whether they’re treated fairly? So if a public pension is holding bonds so that their members can retire at age 55 at a six figure annual pension, 80% funded by the public, they should receive preference over an 80 year grandma who bought a bond fund and is living off social security plus a few hundred bucks extra every month form the fund?

The worst abuse of this system was in the auto industry, when Obama and the Dems cheated the bond holders to give away the company equity to the unions, and avoided bankruptcy court in order to make it happen. Much of the losses where hitting the pension funds from the automakers suppliers who bought into them. When UAW pensions are protected while non-union pensions are ravaged, there is no justice.

Comment by Arizona Bob Tuesday, May 12, 15 @ 1:00 pm
So I assume given your statements, Bob, that you would have been ok with gouging people’s pensions so long as it was pensions of union members? I’ll never understand this absolute hatred some have towards unions.

And dove-tailing off of the post about banned words, I’d ban anybody from bringing up Obama or Bush to make any point.

Comment by Demoralized Tuesday, May 12, 15 @ 1:20 pm
Judgment Day - Thank you!! Great explanation!!!

Comment by jerry 101 Tuesday, May 12, 15 @ 1:21 pm
== When UAW pensions are protected while non-union pensions are ravaged, there is no justice. ==

Which is why all pensions should be 100% protected in the private sector also and bust-out artists should not be allowed to dump said said on the PBGC (us taxpayers).

Comment by RNUG Tuesday, May 12, 15 @ 1:28 pm
Trade creditors often have a contractual arrangement that makes their claims more senior to those of bondholders. For example, they may have a contract, a purchase order, a sales agreement, or the like. Of course, the court and the other creditors will want to verify the seniority as well as ensure that there were no games being played to hide assets before bankruptcy.

Different bonds do have different seniority, and the investors should know that before they buy them.

A bankruptcy judges have to make hard decisions while they follow the law. A good bankruptcy judge can explain it so that everyone knows why a decision was made, even though a lot of people will be unhappy. The law does not treat all creditors equally - and the creditors should know that upfront. That’s the risk they take to get a return that’s higher than the return on a federally insured bank CD.

Comment by AnonAdjunct Tuesday, May 12, 15 @ 1:29 pm
Thank you for pointing that out RNUG. It’s time that people stand up and push back against the “race to the bottom” attitude permeating our society because of the plutocracy and their (pretty) successful efforts to pit middle class workers against each other. We should all be fighting for decent retirement benefits for public AND private employees and personally, I would love to see those funds come out of the baby-soft hides of the Rauners, Griffens, Zells and John Arnolds of the world.

Comment by kimocat Tuesday, May 12, 15 @ 2:21 pm
It should be clarified that most shaky municipal bonds are insured against default. When you invest in a Muni, you don’t pay for the insurance, it is provided on the issuer’s end. So investors are not the losers, it is the insurance companies that take the hit, and have to make bondholders whole.

Comment by grumpy Tuesday, May 12, 15 @ 2:30 pm
The larger point is: interest rates on muni debt will have to go higher holding everything equal to compensate for the risk of being shafted in bankruptcy court.

Comment by Steve Tuesday, May 12, 15 @ 2:31 pm
Bankruptcy judges in Stockton CA and Detroit both opened the door for pensions cuts. In the Stockton case, Judge Klein practically pushed for it; Stockton declined. Pensions can be cut if the entity in bankruptcy chooses to make that part of the plan. The IL state constitutional language protecting pensions has no bearing in a Federal bankruptcy court.

Comment by Anonymous Tuesday, May 12, 15 @ 2:49 pm
The multiple bankruptcies in California and the landmark case in Detroit had virtually no impact on the muni bond market. One deal in Michigan got held up temporarily, then was sold to the market shortly after. The composition of the market does not lend itself to any strong imposition of pricing discipline.

Comment by Anonymous Tuesday, May 12, 15 @ 2:52 pm
Grumpy, the muni bond insurance industry was wiped out in 2008. Holding too much AAA-rated subprime paper.

It’s crawling back now, but market penetration is less than five percent.

Comment by Wordslinger Tuesday, May 12, 15 @ 3:03 pm
Arizona Bob, tax-free municipal bonds are almost exclusively held (ultimately) by investors in high tax brackets. This is called the clientele effect in Finance. If you are, say, in the 35% marginal income tax bracket, the tax exemption is worth more to you than for someone in a 15% bracket; consequently you are rationally quite willing to pay a higher price (i.e. accept a lower yield to maturity) on the muni bond, and in a reasonably efficient market tax-exempt bonds will be held by high tax-bracket investors and taxable bonds will be held by low (or zero) tax bracket investors. State and local pension funds will not hold muni bonds because they pay no taxes, and it would be irrational for them to do so. Yes, many muni bonds are held by bond funds, but the funds are just intermediaries for the ultimate owners - high income, high tax-bracket individuals who hold these assets outside of retirement accounts and are thus fully able to exploit the tax advantages that they offer.

I am not advocating that states should default on their bonds, any more than on their pensions, but if default truly is unavoidable it is perplexing (to use the most civil word I can think of) to argue that bondholders should have higher priority than pensioners.

Comment by Andy S. Tuesday, May 12, 15 @ 3:06 pm
=== Thank you for pointing that out RNUG. It’s time that people stand up and push back against the “race to the bottom” attitude permeating our society because of the plutocracy and their (pretty) successful efforts to pit middle class workers against each other. We should all be fighting for decent retirement benefits for public AND private employees and personally, I would love to see those funds come out of the baby-soft hides of the Rauners, Griffens, Zells and John Arnolds of the world. ===

Yes! Yes! Yes!

Comment by forwhatitsworth Tuesday, May 12, 15 @ 3:44 pm
@anon: Not so sure -”they really don’t want bankruptcy.”

Bankruptcy was a key tool in Rauner’s success, and it expresses attitudes about government held by some of his national allies and funders. Hope you’re right.

Comment by walker Tuesday, May 12, 15 @ 4:27 pm
Call Peter Francis Geraci . . .

Comment by AnonAdjunct Tuesday, May 12, 15 @ 5:23 pm
Wordslinger: your numbers are certainly right, but the articles I read said most of the muni bond defaults of Detroit, Stockton, and Harrisburg were in that small post-crisis percentage that were insured. And the insures paid out, and were touting it.

Comment by grumpy Tuesday, May 12, 15 @ 5:40 pm