The Death Of A City: Detroit’s Eulogy As Delivered By Kevyn Orr

– The Death Of A City: Detroit’s Eulogy As Delivered By Kevyn Orr (ZeroHedge, July 19, 2013:

From the bankruptcy court declaration filed by Kevyn D. Orr in support of the Detroit Chapter 9 Petition.

After decades of fiscal mismanagement, plummeting population, employment and revenues, decaying City infrastructure, deteriorating City services and excessive borrowing that provided short term band-aids at the cost of deepening insolvency, the City of Detroit today is a shadow of the thriving metropolis that it once was. The City does not provide basic and essential services to the residents who remain in the City. Crime is endemic. The City is infested with urban blight, which: (a) depresses property values; (b) provides a fertile breeding ground for crime and tinder for fires (with the attendant disproportionate devotion of police and firefighting resources to abandoned lots); and (c) compels the City to devote precious resources to demolition.

Significant additional resources are required to improve public safety before the City can begin its rehabilitation. City operations, policies and procedures must be streamlined and overhauled to implement best practices and eliminate waste and inefficiencies. Related to this, the City’s technology systems are in desperate need of upgrades, as they have been neglected for years, and the City’s systems are not integrated. In short, the City requires substantial investment to allow it to: (a) provide basic, essential services to current residents; (b) attract new residents and businesses to foster growth and redevelopment; and (c) ultimately begin what will be a long recovery.

The City’s current financial obligations prevent this recovery. The City has over $18 billion in accrued obligations – approximately $11.9 billion in unsecured obligations to lenders and retirees and over $6.4 billion in obligations backed by enterprise revenues or that are otherwise secured (collectively, the “Revenue Bonds”). Currently, more than $0.38 of every tax dollar that the City collects goes to service legacy debt and other obligations rather than toward providing services for the City’s residents and businesses. If nothing changes, that number is expected to grow to almost $0.65 of every dollar in less than five years.

For years, the City has spent more than it takes in and has borrowed and deferred paying certain obligations to make ends meet. The City is insolvent. Excluding the proceeds of debt issuances, the City has incurred operating deficits for each of the past six years through fiscal year 2013. As of the end of the City’s 2012 fiscal year, the City had an accumulated unrestricted general fund deficit of $326.6 million, an increase of $130.0 million over fiscal year 2011. Excluding the impact of a recent debt issuance generating approximately $137 million in proceeds for the City, this deficit increased by an additional $47.4 million in fiscal year 2013

The City also has experienced negative cash flow for years, and that trend is expected to continue and accelerate if not addressed. The City had negative cash flows of $115.5 million in fiscal year 2012, excluding the impact of proceeds from short term borrowings. In March 2012, to avoid running out of cash, the City borrowed $80 million on a secured basis. Absent ongoing cash conservation steps (primarily in the form of non-payment or deferral of obligations that are due and payable and cost-cutting), the City would have run out of cash before the end of fiscal year 2013 (i.e., June 30, 2013).

The City had a positive general fund cash balance net of accumulated property tax distributions of $36.0 million as of June 30, 2013, but only as a result of: (a) deferring approximately $108 million of current and prior year pension contributions (including approximately $37 million in pension contributions for fiscal year 2012 and an estimated $71 million in such contributions for fiscal year 2013); (b) drawing $10 million of the escrowed proceeds of the recent $129.5 million debt issuance; and (c) the City’s recent decision not to make the scheduled $39.7 million payments due to certain pension-related service corporations, among other cash conservation measures.

Absent restructuring, the City is projecting cash flows of negative $198.5 million in the current 2014 fiscal year and negative $260.4 million in fiscal year 2015. This cash depletion would leave the City in a net cash position (after required property tax distributions) of negative $11.6 million as early as December 2013. In the absence of restructuring, the City’s net negative cash position (after required property tax distributions) will continue its downward spiral, reaching negative $143.3 million as of the end of the current 2014 fiscal year and negative $404.5 million as of the end of fiscal year 2015.

As noted above, the City has not been – and currently is not – paying its debts as they come due. For example, the City has deferred payment of pension funding contributions to both its General Retirement System (“GRS”) and Police and Fire Retirement System (“PFRS” and, together with the GRS, the “Pension Systems”), and it accrues interest on such deferrals at a rate of 8%.

As of June 30, 2013, the City had deferred approximately $108 million in contributions to the Pension Systems in the aggregate. In addition, to conserve cash for City operations, including payroll, the City did not make the scheduled $39.7 million payments under certain pension-related service contracts  that were due on June 14, 2013.

Faced with several years of expenditures exceeding revenues, the City has taken aggressive steps to address its financial distress. These measures included: (a) entering into a consent agreement with the State of Michigan and the resulting creation of a financial advisory board to oversee the City’s operations and conduct limited reforms; (b) reducing the number of City employees by more than 22% since fiscal year 2010; (c) implementing revised City employment terms (“CETs”) for non-union employees and union employees under expired collective bargaining agreements; (d) increasing certain tax and utility rates; (e) enhancing tax collection initiatives; and (f) reducing other expenditures. By these reforms, the City estimates that it has been able to realize more than $200 million in annual savings.

Unfortunately, these savings have not been sufficient to balance the City’s budget or improve its cash position. Moreover, as a practical matter, the City cannot meaningfully increase revenues by raising taxes. Citizens of Detroit already pay significantly more taxes than citizens of surrounding communities. The City’s current tax rates are at their statutory maximums and, even if the City could raise taxes, its residents lack the financial wherewithal to bear  them. Nor  can the City significantly reduce expenditures at this time by further reducing employee headcount or cutting services beyond the skeleton coverage currently provided given the archaic state of the City’s technological systems and certain mandates in the City’s Charter. Further cuts would only further jeopardize public health, safety and welfare.

If left unchecked, the City’s deteriorating financial condition will only get worse. The time to stop the downward spiral is now. Along with my team of advisors, I have crafted a plan to permit the City to pay its employees and its bills, live within its means, provide meaningful (but modest relative to the overall need) reinvestment in the City of approximately $125 million annually for the next 10 years, satisfy secured obligations and restructure unsecured obligations. That proposed plan, the negotiations around it, the challenges confronting the City and past attempts to meet them are described in more  detail below. Unfortunately, despite good faith efforts by the City to negotiate with its  creditors (where such negotiations could be had), no reasonable alternative for the restructuring of the City’s operations and obligations exists other than through this chapter 9 case.

Detroit’s Steady, Precipitous Decline

The financial decline that has led Detroit to this debt adjustment case is not of recent origin. Rather, Detroit’s decline is the product of a confluence of demographic and economic forces that have been mounting for decades.

In 1952, at the height of its prosperity and prestige, Detroit – rightfully referred to as the cradle of the American automobile industry – had a population of approximately 1.85 million, a 600% increase from the population in 1900. Detroit’s population explosion coincided with the rise of the automakers. From 1900 to 1930, Detroit was the fastest-growing city in the world and by 1929 it was the fourth-largest city in America. In 1950, Detroit was building half of the world’s cars. During that time, half a million people came to Detroit looking for work.

Population Loss. Since its peak in the 1950s, however, Detroit has been losing both people and jobs. Detroit’s population declined by nearly 45% to just over one million as of June 1990. In the 23 years since, this population decline has continued unabated. Detroit’s population stands at 684,799 as of December of 2012, an astonishing 63% decline from its postwar peak of 1.85 million residents. Detroit has gone from the fifth largest city in America in 1950 to the eighteenth largest today. No other American city has experienced a comparable decline in population over a similar period of time.

The Decline of Detroit Manufacturing. A considerable amount of migration out of the City has been, and continues to be, a result of economic dislocation. In particular, changes in the auto industry over the years have had an outsized impact on Detroit’s economy. Almost immediately after World War II, Detroit began to lose manufacturing jobs as the auto companies automated their facilities and moved their remaining jobs out of the City. Between 1947 and 1963, Detroit lost approximately 150,000 manufacturing jobs as smaller auto manufacturers disappeared (e.g., Packard and Studebaker), and the “Big Three” began to move operations to the suburbs and out of the state.

These trends only accelerated as the Detroit automakers began to lose ground to international competitors. Foreign automakers entered the U.S. market during the 1950s with fuel-efficient vehicles and, when the oil crisis of 1973 hit, U.S. automakers were unprepared. Automobile production fell nearly 30% in the next two years, and the market share of U.S. automobile companies declined from 95% in 1955 to 75% in 1980. By 2008, Detroit’s share of U.S. auto sales had declined to 47%.

The collapse of Detroit’s manufacturing industry during the second half of the 20th century was not limited to the automobile sector. Non-auto companies also shuttered operations. In the 1970s and 1980s, companies such as Uniroyal, Vernor’s Ginger Ale and Revere Copper closed their plants and left abandoned sites behind. From 1972 to 2007, the City lost approximately 80% of its manufacturing establishments and 78% of its retail establishments.

Bleak Employment Prospects. The demise of Detroit’s industrial sector has proven catastrophic for its citizens’ employment prospects. The number of jobs in Detroit (for residents and non-residents) declined from 735,104 in 1970, to 562,120 in 1980, to 412,490 in 1990, to 346,545 in 2012. The “Great Recession” of the past decade dealt an especially punishing blow. Detroit’s unemployment rate already stood at an alarming 16% as of June 2008. When the recession took hold, the production and sales of automobiles in the U.S. cratered. Combined sales for Detroit’s automakers fell from 8.1 million in 2007 to 4.6 million in 2009, with two of the Big Three and numerous parts suppliers filing for bankruptcy in 2009.38 The decline in production and restructuring of Detroit’s auto industry resulted in massive job cuts. Detroit’s unemployment rate skyrocketed to 23.4% as of June 2010 and remained above 18% well into 2012. The number of employed Detroit residents fell sharply, from approximately 353,000 in 2000 to less than 280,000 in 2012.

Eroding Tax Bases & Declining Revenues. Declines in both population and the economy are mutually reinforcing trends. As more people leave the City, there is less economic activity and, thus, a decreased need for workers. Less economic activity and fewer jobs induce even more people to leave, thus further reducing economic activity and exacerbating job losses. Detroit has been in the grip of this vicious spiral for decades, and it has taken a  remendous toll on the City’s ability to generate revenue. Detroit’s municipal income tax receipts – traditionally the City’s largest source of revenue – have decreased by approximately $95 million (or 30%) since 2002 and by $43 million (or more than 15%) since 2008, driven lower primarily by high unemployment and declining per capita income.

Detroiters’ average per capita annual income from 2007 to 2011 was $15,261; the median household income for that same period was $27,862. During that period, an estimated 36% of Detroiters were living below the poverty line. Only 54% of Detroiters owned a home, the median value of which was $71,100. To put these numbers in perspective, the average per capita annual income in Michigan from 2007 to 2011 was $25,482 the median household income was $48,669 and only 16% of Michigan citizens lived below the poverty line. The state-wide homeownership rate was 74%, and the median home value was $137,300.

Detroit’s property tax receipts likewise have suffered. Between 1970 and 1990, the real value of the City’s property tax base declined by nearly two-thirds. This trend has reasserted itself in earnest in the wake of the Great Recession. According to the Citizens’ Research Council of Michigan, over the last five years, Detroit’s assessed property values have decreased by approximately $1.6 billion. Property tax revenues for the City’s 2013 fiscal year were $134.9 million, a $12.9 million (or approximately 10%) reduction from the prior fiscal year and $23.6 million (or approximately 15%) lower than the average property tax revenue for the preceding five fiscal years Ancillary taxes imposed by the City likewise have either declined or are expected to decline on a prospective basis. Detroit is the only city in Michigan to impose a “utility users’ tax” on its citizens. The City’s receipts from this utility users’ tax have decreased approximately 28% over the last decade (from approximately $55.3 million in fiscal year 2003 to approximately $39.8 million in fiscal year 2012). Detroit is also the only municipality in Michigan authorized to levy a casino wagering tax. Although these wagering tax revenues recently have remained steady, the City estimates that such revenues will decrease in fiscal year 2013 by approximately 5% and fail to recover to their fiscal year 2012 level until fiscal year 2023 due to expected loss of market share to casinos opening in nearby locations (e.g., Toledo and Cleveland, Ohio).

Detroit receives unrestricted aid from the State of Michigan in connection with constitutional and statutory sharing of sales tax revenue and “economic vitality incentive payments.” Due to the City’s declining population and significant cuts by the State, Detroit’s share of distributed state revenue for fiscal year 2012 had decreased by more than $161 million (or approximately 48%) since fiscal year 2002 and by approximately $76 million (or approximately 31%) since 2008. Although higher projected tax revenues collected by the State are expected to halt the decline in the City’s receipt of shared revenue over the coming fiscal years, revenue sharing payments: (a) remain at risk of further decrease given the City’s declining population; and (b) are projected to remain approximately 20% below fiscal year 2011 levels for the foreseeable future.

No Ability to Ameliorate Cash Losses by Raising Taxes. A number of factors render the challenges posed by the City’s declining tax revenue essentially intractable. The per capita tax burden on Detroit residents is the highest in Michigan, which burden is made heavier still by the residents’ relative inability to pay given their level of per capita income. The City’s income tax – 2.4% for residents, 1.2% for non-residents and 2.0% for businesses – is the highest in Michigan, and Detroiters pay the highest total property tax rates of residents of Michigan cities with a population over 50,000 (inclusive of property taxes paid to overlapping jurisdictions (e.g., the State; Wayne County)).

In any event, the City is currently levying all taxes at the statutory maximums. In particular: (a) Public Act 394 of 2012 of the State of Michigan fixed the City’s maximum income tax rates at their current levels. (b) State law limits municipalities’ property tax rates to 20 mills and a constitutionally-required “Headlee rollback” further limits that rate to 19.952 mills (which is the rate charged by the City); and (c) the utility users’ tax and casino wagering tax are fixed at their current 5% and 10.9% levels, respectively, by the State statutes authorizing these Detroit-specific taxes.

High Crime Rates. During calendar year 2011, approximately 136,000 crimes were reported in the City; 15,245 of these were violent crimes (e.g., homicide, forcible rape, robbery, aggravated assault). In 2012, the City’s violent crime rate was five times the national average and the highest of any city with a population in excess of 200,000. In 2011, the number of murders, non-negligent manslaughters and aggravated assaults in Detroit exceeded that of Cleveland, Pittsburgh, St. Louis and Milwaukee combined. The City’s case clearance rates for violent crimes and all crimes (18.6% and 8.7%, respectively) are substantially below that of comparable municipalities nationally and surrounding local municipalities, and the response times of the Detroit Police Department are far in excess of comparable and surrounding cities.

Certain business owners have taken the extraordinary step of hiring off-duty police officers and renting police cruisers to patrol certain sections of the City underserved by the DPD.

Non-Functioning Street Lights. As of April 2013, about 40% of the approximately 88,000 street lights operated and maintained by the City’s Public Lighting Department (“PLD”) were not working, primarily due to disrepair and neglect. Many outages are attributable to burned-out bulbs, but others are the result of the obsolescence of the distribution-only electrical grid maintained by the PLD. The total of functioning street lights per square mile in Detroit generally is less than half that of comparable national municipalities. This failure in the provision of basic municipal service – the City is literally struggling to keep the lights on – is compounded by the fact that many of the street lights that are working do not meet the residents’ actual needs. Functioning street lights often serve under-populated sections of the City’s historical population footprint, and there is a backlog of approximately 3,300 complaints related to the City’s lighting.

Blight. Perhaps no issue is as fundamental to – or emblematic of – Detroit’s decline as urban blight. The City’s long-term population decline and falling property values have resulted in large numbers of abandoned, forfeited or foreclosed land and structures within the City. These decrepit eyesores dramatically undermine Detroit’s efforts to maintain public safety (as they contribute to the proliferation of crime and arson) and contribute to declines in property values.

There are approximately 78,000 abandoned and blighted structures in the City (approximately 20% of the City’s housing stock), nearly half of which are considered dangerous. This number increases steadily due to vacancy (particularly foreclosures) and fires, among other things.

Approximately 60% of the 11,000 to 12,000 fires that the City has experienced each year for the past decade occur in blighted and unoccupied buildings, forcing the Detroit Fire Department (“DFD”) to expend a disproportionate amount of time and resources fighting fires in vacant structures. Similarly, there are approximately 66,000 blighted and vacant parcels of real property within the City limits.

Compounding this problem is the fact that removing blight is an expensive, time-consuming and highly-regulated endeavor. The average cost to demolish a residential structure (accounting for surveys and abatements, utility disconnection costs, administrative costs and the demolition itself) is approximately $8,500. The current regulatory framework – involving multiple codes and regulations and a number of jurisdictions – increases costs and slows the process.

Aging, Dysfunctional Infrastructure and Equipment: Police, Fire & EMS. Numerous City assets are in states of neglect and disrepair. The infrastructure and equipment for the City’s police, fire and EMS departments, in particular, are aged and inadequately maintained.  The average age of the City’s 35 fire stations is 80 years, and maintenance costs often exceed $1 million annually. Due to lack of funding, Detroit’s firefighters are often forced to make necessary repairs to the fire stations themselves. The DFD’s fire apparatus fleet is plagued with mechanical issues, contains no reserve vehicles and lacks equipment ordinarily regarded as standard

Once staffed with 63 people and now down to 26, the DFD’s Apparatus Division has a mechanic to vehicle ratio of 1 to 39, resulting in an inability to complete preventative maintenance on schedule. Detroit firefighters frequently operate shorthanded due to a lack of serviceable equipment. The City has recently accepted donations towards the inspections of fire ladders on trucks and ground ladders because the City could not afford required inspections. Indeed, in February 2013, Detroit Fire Commissioner Donald Austin ordered firefighters not to use hydraulic ladders on DFD ladder trucks except in cases involving an “immediate threat to life” because the ladders had not received safety inspections “for years.”

The City’s EMS vehicles suffer from similar problems. During the first quarter of 2013, frequently only 10 to 14 of the City’s 36 ambulances were in service. Some of the City’s EMS vehicles have been driven 250,000 to 300,000 miles and break down frequently. Again, the City has been forced to accept charitable donations to upgrade its EMS fleet. In March 2013, a group of corporations pledged to donate approximately $8 million to the City, a portion of which will be used to upgrade the city’s fleet of EMS vehicles. Similarly, the DPD operates with an extremely old fleet of 1,291 vehicles, a majority of which have reached replacement age and lack modern information technology.

Parks and Recreation. The number of City parks is dwindling, and many are in poor or fair condition due to lack of funding. The City closed 210 parks during fiscal year 2009, reducing its total by 66% (from 317 to 107), and recently announced that 50 of its remaining 107 parks would be closed, another 38 would shift to limited maintenance and the already under-served Belle Isle would receive decreased services.

Information Technology. Nearly all of the City’s departments are saddled with obsolete and non-integrated information technology (“IT”) infrastructure and software. The IT systems employed by the DPD and DFD: (a) are outdated to the point that vendors no longer provide full support; and (b) lack integrated solutions, resulting in redundant data entry, no meaningful reporting and limited query capabilities. DPD’s IT systems, in particular, are highly manual, poorly implemented and non-integrated, resulting in highly inefficient DPD operations; the DPD has no IT systems in place at all for such functions as jail management, electronic ticketing and activity logs.

The City’s payroll systems are similarly anachronistic, resulting in massive inefficiencies and excessive costs. The City currently uses multiple, non-integrated payroll systems that are highly manual and prone to human error and erroneous payments. A majority of the City’s employees are on an  archaic  payroll system that has limited reporting capabilities and no way to clearly track, monitor or report expenditures by category. Accordingly, the City’s cost of payroll administration is significantly higher than for comparable entities.

Current cost to process payroll is $62 per check ($19.2 million per year), which is more than four times more costly than the general average of $15 per paycheck, and almost 3.5 times more costly than other public-sector organizations, which average $18 per paycheck. The payroll process involves 149 full-time employees, 51 of which are uniformed officers – meaning that highly and expensively trained and high cost personnel are performing clerical duties.

Similar IT issues handicap the City’s tax collection systems.

The City’s highly manual income tax collection and data management systems are simply outdated (having been purchased in the mid-1990s) with little to no automation capability; in July 2012, they were characterized as “catastrophic” by the IRS. The billing, processing and collection of property taxes are likewise inefficient. Recommendations recently received from a third-party consultant designed to increase the efficiency of the City’s property tax collection process have not been implemented, and the City must rely on Wayne County for funding and the collection of delinquent property taxes.

The City’s core financial, accounting and budgeting systems  similarly suffer from the lack of modern IT. The City’s financial reporting and budget development systems: (a) are 10 to 15 years old; (b) require a manual interface (70% of journal entries are booked manually); (c) lack reliable fail-over and back-up systems; and (d) lack a formal, documented IT governance structure, all of which impairs the reporting, efficiency and accuracy of the data  and the accountability of the systems. The City’s grant tracking systems are fragmented and unstandardized to the extent that the City is unable to comprehensively track citywide grant funds and status or prevent disallowed costs. Aged IT infrastructure within the City’s Buildings, Safety Engineering and Environmental Department (“BSEED”) and the DFD leads to bottlenecks in permit invoicing and collection.Finally, to improve both service and safety, the Detroit Department of Transportation (“DDOT”) requires funding for technology updates (e.g., GPS/bus cameras) both on its buses and at DDOT facilities.

Growing Budget Deficits

The City has run substantial deficits (excluding financing proceeds) for the last six fiscal years of approximately $128 million (2008), $124 million (2009), $72 million (2010), $57 million (2011), $122 million (2012) and $47 million (2013). Including the effect of recent debt issuances (e.g., $75 million in fiscal year 2008; $250 million in fiscal year 2010; $129.5 million in fiscal year 2013) (the “Recent Debt Issuances”), the City’s accumulated general fund deficit stood at approximately $327 million as of the end of fiscal year 2012 and $237 million as of the end of fiscal year 2013. Excluding the effect of the Recent Debt Issuances (which, as an accounting matter, reduce the amount of the accumulated deficit by an amount equal to the funds borrowed), the City’s accumulated general fund deficit: (a) has grown continuously over an extended period; and (b) would have been over $650 million for fiscal year 2012 and approximately $700 million for fiscal year 2013. Absent structural changes at its current run rate, the City’s accumulated deficit could grow to  approximately $1.3 billion by fiscal year 2017.

The City has funded its continuing deficits in a variety of ways, including: (a) deferral of pension contributions (resulting in larger funding deficits and requirements for additional contributions in later periods); (b) issuance of short term and long term debt; (c) deferral of trade payments; and (d)  borrowing by the general fund from other funds, deferrals and cash pooling. As of June 30, 2013, the City’s general fund had outstanding deferrals and amounts due to other funds and entities of approximately $274.3 million: (a) approximately $53.8 million owed to other funds; (b) approximately $77.2 million of other funds’ cash held in the general fund’s operating account; (c) approximately $35.3 million owed to other taxing authorities; and (d) approximately $108 million in deferred pension contributions owing for the current and prior fiscal years.

Insolvency

As a result of the City’s recurring operating deficits, the City has continued to experience liquidity problems as it has depleted all cash reserves. For years, the City’s cash shortfalls have been addressed through the issuance of short term and long term debt. As noted above, the City’s Recent Debt Issuances provided the City with approximately $460 million in proceeds. To avoid running out of cash, in March 2012, the City borrowed $80 million on a short term, secured basis (of which the City spent $50 million in fiscal year 2012). More recently, the shortfalls have been addressed with deferrals of payments on current obligations, wage cuts, employee furloughs/layoffs, cash pooling, borrowings from other City funds and other working capital tactics.

Further, the City’s ability to access the credit markets to satisfy its cash needs is compromised by its plummeting credit ratings. The City’s credit ratings have reached historic lows and currently are below investment grade. No major U.S. city has a lower credit rating than Detroit. As of June 17, 2013, S&P and Moody’s had lowered Detroit’s credit ratings to CC and Caa3, respectively.

Demolition Initiatives.

In April 2010, the City launched a program to take initial steps towards addressing the critical issue of urban blight within the City limits. This program had the goal of demolishing 10,000 vacant structures (i.e., approximately 13% of the vacant structures within the City and 26% of such buildings classified as dangerous) within three years. Over 5,000 structures have been demolished, but the City lacks sufficient funding to complete the project by its target date of December 2013. The City has also commenced an ancillary demolition initiative in partnership with the State of Michigan, pursuant to which $10 million has been allocated to the targeted demolition of 1,234 structures located in the vicinity of schools. As of February 28, 2013, 179 structures had been demolished pursuant to this ancillary initiative (and another 56 were under contract to be demolished)

Meetings with Respect to Employee Legacy Obligations.

Both prior to and after my appointment, many of the City’s financial and legal advisors have been analyzing the City’s retiree healthcare and pension obligations. These advisors have been developing ideas for restructured programs that would preserve healthcare and retirement benefits for retirees, to the extent feasible, in a structure that the City will be able to afford in light of its projected cash flows and other critical needs over the next decade.

On June 20, 2013, certain of these advisors met in Detroit with representatives of all of the City’s unions and four retiree associations. These meetings were conducted in discrete morning and afternoon sessions (addressing “non-uniformed” and “uniformed” personnel/retirees, respectively) at which the City: (a) presented a more in-depth look at its analysis of its retiree health and pension obligations; and (b) suggested proposals for the modification thereof that the City could fund within its means going forward. Representatives and advisors of the Pension Systems attended both meetings.

Approximately 100 union and retiree representatives attended the two-hour morning session for non-uniformed employees and retirees. Questions were solicited, and the City’s advisors answered as many of them as could be answered before the meeting time concluded. Approximately 35 union and retiree representatives attended the afternoon session for uniformed employees and retirees, which lasted approximately 90 minutes. Questions were solicited,  and the City’s advisors answered all questions posed. The City provided handouts of the presentations at both meetings and, after the meetings, posted such presentations in the Data Room (as such term is defined below) that the City has established as a repository for information that creditors may find relevant in their evaluation of the City’s proposals.

Both at the beginning and at the conclusion of each meeting, the City’s advisors stressed that the City welcomed the unions’ and retirees’ views. Because the modifications proposed by the City are dramatic (albeit necessary), the City clearly expressed its desire to engage in a dialogue regarding the unions’ and  the retirees’ preferred approach to address the required changes that are expected to be severely dislocating for retirees.

Understandably, the employees’ and retirees’ reactions to these meetings were less than enthusiastic; there were expressions of distress and, in some cases, anger. Certain union representatives publicly called for litigation and swore that they would not countenance discussions over proposals to modify either retiree healthcare or pensions. Others took a more constructive approach. On June 27, 2013, the City’s advisors contacted all union representatives that had attended any prior presentations by, or meetings with, the City and/or its advisors to invite additional requests for information and diligence from such parties.

Negative Cash Flow.

The City had negative cash flows of $115.5 million in fiscal year 2012.The City’s preliminary estimates show positive cash flows of $31.5 million (excluding the impact of borrowings) for fiscal year 2013, but only as a result of, among other things, the deferral of nearly $108 million in pension contributions and the City’s recent decision, on June 14, 2013, not to make $39.7 million in payments due and owing to the Service Corporations. As of June 30, 2013, the City had only $36 million in cash on hand (net of accumulated property tax distributions), but had outstanding deferrals (including the $108 million in deferred pension contributions referenced above) and amounts due to other funds and entities of approximately $274.3 million.

Absent restructuring, the City is projecting cash flows of negative $198.5 million in the current 2014 fiscal year and negative $260.4 million in fiscal year 2015. This cash depletion would leave the City in a net cash position (after required property tax distributions) of negative $11.6 million as early as December 2013. In the absence of restructuring, the City’s net negative cash position (after required property tax distributions) will continue its downward spiral, reaching negative $143.3 million as of the end of the current 2014 fiscal year and negative $404.5 million as of the end of fiscal year 2015. Accordingly, the City (a) is not paying its debts as they come due and (b) is unlikely to be able to service its debts in the foreseeable future. The City is insolvent.

Barriers To Reaching Agreement

The City cannot practicably negotiate a consensual restructuring with any of its key constituencies in an out-of-court setting. The pool of potential creditors in this chapter 9 case is vast. The City estimates that the number of employees, retirees, vendors, bondholders, insurers and other parties in interest in this case reaches into the many tens of thousands (and that many of these creditors are presently unknown and unidentified). Collectively, these parties hold claims against the City in the amount of more than $18 billion. Moreover, some of the largest components of the City’s debt — including, for example, the obligations — are fragmented among numerous individuals as opposed to being centralized with a single entity.

With respect to the City’s retirees, many of the unions have taken the position that they do not and cannot represent their former members who are current retirees. It is my understanding that, absent their consent, the approximately 20,000 retirees entitled to receive retiree healthcare and pension benefits from the City cannot be bound by out-of-court negotiations between the City and the 47 discrete bargaining units of the 28 unions that might represent these retirees. Moreover, even if such retirees were willing to be bound by the City’s negotiations with its various bargaining units (which is unlikely), the majority of those units have expressly refused to represent such retirees. Despite City’s actuarially accrued $6.4 billion in unfunded other post employment benefit the City’s best efforts to organize the retirees prior to the commencement of this chapter 9 case, most retirees remained unrepresented in negotiations. Accordingly, the negotiation of changes to pension and retiree benefits with the City’s retiree constituency – changes that are critical to any restructuring of the City given the approximately $9 billion owed to these constituencies – is impracticable (if not impossible) outside of the chapter 9 context.

Although the City could not practicably negotiate with its entire creditor body, as described above, it has nevertheless attempted, in good faith, to negotiate with many key creditors, presenting its proposals to all known constituencies and soliciting feedback and engaging in meetings with all parties willing to come to the table. However, the fragmented and often non-binding nature of these negotiations has frustrated the City’s ability to negotiate a consensual restructuring of its debt.

Moreover, the City’s restructuring proposals have met with resistance from a number of its creditor constituencies. For example, on July 3, 2013, multiple lawsuits were filed by certain of the City’s employees (both active and retired) against the Governor and Treasurer seeking, among other things: (a) a declaratory judgment that PA 436 violated the Constitution of the State of Michigan to the extent that it purported to authorize chapter 9 proceedings within which vested pension benefits might be compromised; and (b) an injunction preventing the defendants from authorizing any chapter 9 proceeding for the City within which vested pension benefits might be adjusted. On July 17, 2013, the Pension Systems commenced a similar lawsuit against me, in my capacity as Emergency Manager, and the Governor, seeking declaratory judgments that PA 436: (a) does not authorize the defendants to take any action that may result in the compromise of the City’s pension obligations; and (b) when read in conjunction with the Michigan Constitution, requires the defendants to refrain from attempting to compromise pension obligations within a chapter 9 proceeding (or, alternatively, that PA 436 violates the Michigan Constitution).

Commencement of Chapter 9 Proceedings

Unable to negotiate an out-of-court resolution that simultaneously addressed the City’s dire financial situation while laying the foundation for a strong and prosperous City going forward (and with no prospect of such a resolution), on July 16, 2013, and in accordance with section 18(1) of PA 436, I recommended to the Governor and the Treasurer in writing that the City file for chapter 9 relief. A copy of my recommendation is attached hereto as Exhibit J and incorporated herein by reference. This recommendation was based on my judgment that no reasonable alternative to rectifying the financial emergency of the City existed because the City cannot adopt a feasible financial plan that can satisfactorily rectify the financial emergency in a timely manner. On July 18, 2013, in accordance with section 18(1) of PA 436, I received the written authorization of the Governor to commence chapter 9 relief.

And the Appendix: the city’s June presentation to creditors

Detroit Creditor Proposal