The Corrupt Bargain

by Kevin D. Williamson
Detroit’s bankruptcy, a rogues’ gallery.

Detroit has long been run by criminals. Former mayor Kwame Kilpatrick, currently known as prisoner No. 44678-039 in the federal lockup at El Reno, Okla., ran an outright criminal enterprise out of City Hall, and was subsequently convicted on charges ranging from racketeering and extortion to bribery and fraud. He managed to make sewage even dirtier than it is, taking at least $1 million in kickbacks for contracts in the city’s water department. He also signed off on an odd and probably illegal deal to borrow money to make up for city’s habitual underfunding of its pension system, thereby creating a cascading series of problems that remain with the city and have complicated its attempt to restructure its affairs in bankruptcy.

This sorry tale features almost everything there is to hate about governance in these United States: rapacious public-sector unions, a feckless city council that apparently had no idea what it was signing off on, Wall Street banks looking to benefit from political maneuvering, promises of casino revenue, and lawyers — lots of lawyers. That and a mayor with two dozen felony-corruption counts now on his curriculum vitae.

Detroit, like many U.S. cities and states, uses its pension system as a tool for political patronage, but it does it on the cheap. It made extravagant promises about retirement benefits, and put aside very little to make good on those promises. And when the city’s institutions did find themselves with a little extra cash on hand, they habitually squandered it through a separate quasi-criminal enterprise, the so-called 13th-check payments under which public-sector retirees and non-retirees alike were written large bonus checks, on no obvious legal authority, depriving the pension system of some $2 billion in assets.

Now the stupid comes quick and deep: Having looted its pension funds, the city found itself with insufficient money for meeting its promises to retirees. But it could not really walk away from those obligations: Michigan law says that those pensions have to be paid. Having a debt that it could not possibly pay, Detroit, under the leadership of Mayor Kilpatrick and a few Wall Street geniuses, hatched a scheme for Detroit to go into debt in order to pay the debt that Detroit could not pay. Detroit issued so-called pension obligation certificates of participation, basically pension-funding bonds, and those instruments had variable interest rates, putting the city at risk from an upward spike in interests rates. (Happening in 2005, this was.) So, in order to protect itself, Detroit also made a big bet on interest-rate swaps to hedge against rising interest rates. Interest rates collapsed, and the city found itself in hock to UBS and Bank of America to the tune of some $400 million.

Detroit couldn’t make that payment, so it came up with another ingenious plan worthy of Wile E. Coyote: It offered the banks a deal under which its debt would be converted from an unsecured to a secured obligation, i.e., into a debt that has to be paid off during bankruptcy. That secured debt would be backed by real money, with Detroit pledging its future casino revenues to make good on it. That was enough to buy off the Wall Street guys, and to allow them, in turn, to insure themselves against taking a bath on the deal, a service provided to them by a Bermuda-based firm, Syncora Guarantee, which , as a consequence of all of this boneheadedness coming unwound, is today the city’s principal remaining adversary in its bankruptcy case.

Where things get funny is here: Detroit’s advocates have argued, among other things, that the city should try to “claw back” some of those 13th-check payments under “fraudulent conveyances” rules, that the promise of dedicating casino revenues to back the bailout of the pension-funding scheme was illegal and that the city should not, therefore, be held to it — and also that “alleged historical mismanagement or misconduct” of the pension system is legally irrelevant and should be excluded from the bankruptcy hearings in that it would prejudice the judge against the city and “waste precious trial time and judicial resources.” Translation: It was a crime, so you can’t blame us — even though we’re the perpetrators.

Who is responsible? Joseph Harris, formerly the city’s independent auditor, told the New York Times that the excess payments were the city council’s call. “My understanding was, it had to be approved by City Council, and council was under the belief that the money was there.” On the subject of the original deal negotiated under Mayor Kilpatrick, former city council member Sheila Cockrel said: “There was nothing that ever suggested this was sort of a smoke-filled, back-room financial maneuver. This was the mechanism that all the lawyers, bond lawyers, Wall Street lawyers, Detroit lawyers — lawyers were all saying this was the way you do this.”

And that’s how you know something’s a solid bet: Detroit lawyers and Wall Street lawyers are selling it to you.

Syncora, which, as the insurer, inherited a great deal of the financial liability, argues that it is being treated unfairly, and that the city’s pennies-on-the-dollar offer to financial creditors — while imposing only trivial reductions on the pensioners whose benefits are at the root of the problem — is unfair. It argues that the so-called grand bargain under which the state of Michigan and several foundations will offer the city about $800 million in exchange for its vaunted art collection grossly undervalues the art — which is estimated to be worth billions, not millions — deprives creditors of an asset that might be used to make them whole. The city argues that the pensioners can’t be blamed — all they did was take the money — and that city council can’t be blamed, arguing in effect that its members are too stupid to have understood what they were doing. The pinstripes set isn’t looking very good, either: Syncora has warned investors that it doesn’t have enough in its reserves to pay all the claims, should things not go its way.

So we have: a city council too short-sighted and beef-witted to understand what it was doing, a mayor who was an outright criminal, union bosses who never asked where the money was going to come from and union members who simply cashed the checks and never held their leaders to account, banks and financial firms that were happy to bet that they’d be comfortably seated when the music stopped, and lawyers and a court system happy to ignore the fact that the bankruptcy deals being worked out in Detroit are exactly as corrupt and destructive as the policies that put the city into bankruptcy in the first place. And a pox on the people of Detroit, too: They keep voting for this, over and over.  

Judge Steven Rhodes soon will issue a ruling on Detroit’s bankruptcy plan. However he rules, it is a safe bet that history’s verdict will be much harsher: Detroit’s leaders are guilty of murder in the first degree of a once-great American city.

— Kevin D. Williamson is roving correspondent for National Review.