Rick Snyder

Detroit bankruptcy ruling: Winners and losers

December 3, 2013: 5:00 PM ET

This could be good news for city services, but it's very, very bad news for public pensions.

By Anne VanderMey

Kevyn Orr

Detroit Emergency Manager Kevyn Orr

FORTUNE -- Detroit doesn't want a fight.

After U.S. Bankruptcy Judge Steven Rhodes issued a landmark ruling allowing the beleaguered city to seek bankruptcy protection, Mayor Dave Bing told the assembled press core, "We have to mediate the least amount of pain for any one individual. … We don't want to be in a situation where we're pitting the city against the pensioners."

But as much as Bing might want to avoid a battle, Detroit is going to get one anyway. The city's financial and legal troubles are shaping up to be a fierce contest, pitting pensioners against bondholders against city residents. Every party has a legitimate claim to Detroit's money. But with $18 billion in long-term liabilities and little in revenue, there's no way everyone will get paid.

Here's a breakdown of the winners and losers from the ruling:

LOSER: Pensioners

The big surprise from Tuesday's ruling was that city employee pensions, which are protected by state law, could now be reduced. "Pensions are big losers," says University of Michigan bankruptcy law professor John Pottow. "They could have either won, or lived to fight another day, but they actually lost, which I think people didn't predict."

However, Rhodes was careful to stipulate that he wouldn't necessarily approve steep cuts in payouts to retirees -- only that he wouldn't rule it out. The bottom line is that pensioners, who argued that they were protected by state laws, will now have to fight for every dollar.

The judge's call has already earned its share of blowback. "The State Constitution protects [retirees'] rights, unlike all other creditors, yet they receive no special priority over other general creditors," University of Detroit Mercy law professor Larry Dubin said in an e-mail. "May be legal, according to the judge, but doesn't seem fair to me."

WINNER: Bondholders

Less money for pensions will, in theory, mean more money for capital markets creditors. "On the one hand, the bondholders say 'Woohoo! The pensions can be cut,'" says Juliet Moringiello, a professor at Widener Law School in Pennsylvania. "But remember, there's not enough money to pay them either."

The reality in Detroit is that all creditors are looking at diminished paydays. The question now is by how much. Any outcome will have to be judged to be in the best interest of creditors, a category that includes pensioners. "Just because pensions can be cut doesn't mean that bonds can't be cut," Moringiello says. To boot, Emergency Manager Kevyn Orr's original proposal to creditors wasn't exactly generous.

WINNER (sort of): Current city residents

People living in Detroit today are one step closer to that coveted "clean slate" -- a fresh start, debt-free and untainted by Detroit's history of catastrophic financial mismanagement. "I do think we'll see lights come on," Bing said on Tuesday, referring to the 40% of Detroit streetlights that do not function. He added that he also expects improvements to the city's bus service and police response times. The bad news for residents is that haircuts to pensions could affect the local economy, and the art in the Detroit Institute of Arts Museum could still go on the auction block.

WINNER: Governor Rick Snyder

The judge's ruling vindicated Michigan Republican Governor Rick Snyder on several counts. The governor has made a forceful argument in favor of bankruptcy as the best path forward for the city (the judge ruled that Detroit was eligible for Chapter 9), and he overrode elected city officials to install an emergency manager (a move the judge ruled constitutional). Now, Snyder's appointee has even clearer authority. And while Rhodes was less keen on the state's negotiating tactics, essentially saying attempts to negotiate with creditors were only barely done "in good faith," he commended Snyder for not attaching contingencies to Orr's appointment.

LOSER: Public employee unions

The decision to trim pension obligations has nationwide implications. As public institutions struggle with pension and healthcare debt, Detroit's negotiations may set the stage for more pension haircuts. California will be keeping a close eye on this one.

WINNER: America's other bankrupt cities

Calling cash-strapped municipalities "winners" in this case seems like a stretch, especially considering that borrowing costs may increase if municipal bonds are deemed unsafe. But University of Pennsylvania law professor David Skeel says that the ability to negotiate pensions, even a little, could be a big relief to struggling governments. Without some flexibility, he wrote in July, "the downward financial spiral of too many American cities is likely to continue."

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