One of lesser followed aspects of Detroit’s bankruptcy is a lawsuit filed by emergency manager Kevyn Orr to repudiate $1.4 billion in debt by claiming it was illegally issued. This appears to be mostly a negotiating tactic, but if the judge ends up agreeing with this, it will unleash an inferno of municipal moral hazard that will no doubt be exploited by politicians around the country.
Michigan, like many states, limits the amount of indebtedness cities can incur. To top off pensions, former mayor Kwame Kilpatrick borrowed $1.4 billion. To circumvent debt limits, he created special purpose entities to do the borrowing. Orr now claims these were sham entities, and so the debt issue was illegal, so the city is entitled to pocket the $1.4 billion and not pay it back.
Keep in mind that creating special purpose corporations of various types for this sort of purpose is widespread municipally and in the corporate world. Also keep in mind that Kwame Kilpatrick was a crook who’s going to spend the next 28 years in prison for corruption. It’s an interesting claim that an outright criminal who borrows money can claim that because his scheme is crooked he doesn’t have to pay the money back (Both Kilpatrick and Orr were both speaking ex-cathedra as municipal CEO). What kind of logic is this?
If Detroit successfully repudiates this debt, municipal leaders elsewhere would almost have to be idiots not to take advantage of the same trick. Elect a crooked mayor or merely one with few scruples. Borrow an insane amount of money by skating on the edge of the law. Then sue yourself claiming you couldn’t possibly have legally done the deal, so don’t have to pay the money back. Rinse, repeat.
The feds should drop the hammer on this hard on this. I don’t have a lot of sympathy for big banks. On the other hand, when someone takes out the municipal equivalent of a “lair’s loan”, they shouldn’t be allowed to profit from being a crook.
In large municipal bankruptcies, it’s pretty common to claim that the indebtedness is all the fault of those greedy bankers who deceived the poor servants of the public. I believe similar claims were made and generated quite a bit of municipal recovery in Orange County and Jefferson County, Alabama. But look closely and I think where you find a shady banker operating, you’ll often find a shady client as well.
Why do people keep electing crooks like Kilpatrick to office? Well, if it turns out those guys are able to fleece out of town bankers to the tune of $1.4 billion, why wouldn’t you? Looks like he might have cut a pretty savvy deal after all. This sort of behavior shouldn’t be rewarded. You can be sure shady municipal borrowing will only be on the increase if the courts allow the Detroit to play a heads we win, tails you lose game with the banks. Think about that the next time your city engages in legal contortions to dig itself even deeper into debt.
Speaking of Detroit, the free market Manhattan Institute will be doing a one hour live streamed event this Monday the 24th with Michigan Gov. Rick Snyder and Detroit emergency manager Kevyn Orr. It’s at 1pm ET and is called “Detroit: The Next American City of Opportunity.” You can access the event at: http://www.publicsectorinc.org/2014/02/detroit/. If you want to submit questions, tweet them to @ManhattanInst with the hash tag #SaveOurCities.