Detroit files for bankruptcy

July 18, 2013: 7:25 PM ET
detroit protests bankruptcy
Protestors in Detroit last month objected to plans to cut pension benefits of city workers and retirees.
NEW YORK (CNNMoney)

Detroit filed for bankruptcy Thursday, becoming the nation's largest public sector bankruptcy. The move could slash pension benefits to city workers and retirees, and leave bond holders with only pennies on the dollar.

The bankruptcy was filed by Emergency Manager Kevyn Orr and approved by Michigan Gov. Rick Snyder. Snyder said the financial condition of the city left him no choice.

"Now's our opportunity to stop 60 years of decline," Snyder said at a Friday news conference with Orr. "How long had this been going on and people were kicking the can down the road and not doing something? We're doing something."

Snyder has said that 38% of the city's budget is being spent on "legacy costs," such as pensions and debt service. He said police take almost an hour to respond to calls, compared to a national average of 11 minutes, and that 40% of street lights in the city are turned off.

"Does anybody think it's OK to have 40-year-old trees growing through the roofs of dilapidated houses," Orr said.

Related: 16 things that are wrong in Detroit

But public employee unions are sure to fight the move, charging that the city did not negotiate in good faith and should not be allowed to walk away from obligations made to employees and retirees.

The Detroit Fire Fighters Association said it was "very disappointed" with the bankruptcy filing.

"We are working with other Detroit employees to form a unified coalition to address the financial concerns of Detroit," the group said. "Detroit's Fire Fighters will continue to protect and serve during this difficult time, regardless of the economic challenges."

Related: Retired Detroit firefighter -- 'My pension is what I was promised'

Orr already halted payments on about $2 billion in debt last month, saying the city needed to preserve its dwindling supply of cash. The city faces total liabilities of about $18 billion.

Orr's reorganization plan calls for cutting $11.5 billion in debt down to $2 billion. That would mean that investors and retirees would receive an average of just 17% of what they are owed. Specific plans for the cuts are unknown at this time.

No municipal bankruptcy has ever resulted in involuntary cuts to retiree benefits, said Michael Sweet, a California bankruptcy attorney.

"It's relatively easy to blow off a creditor. It's much harder when it's people who are the fabric of your community," he said. "You need a police force, you need a fire department. You're saying [to them] you're not worth what you were previously promised."

Related: Casinos, not cars, are keeping Detroit afloat

Sweet said that case law on whether pensions can be cut this way is very limited, and it could take years for a court fight over such cuts to work its way to the U.S. Supreme Court. Given the poor state of funding for many public sector pension funds nationwide, "it's a big enough question, that (the Supreme Court) is where it likely will have to go," he said.

When employees of a bankrupt business lose their promised pensions, the Pension Benefit Guaranty Corp. steps in and provides a minimal level of benefits. But that federal agency doesn't back pensions in the public sector.

Related: Detroit bankruptcy filing came with only 5 minutes to spare

Retirees and city employees say they can't accept cuts in their pension benefits.

"How am I supposed to live without my pension?" said David Sole, 65, after a protest in Detroit last month. Sole retired from the city's water department in January after 22 years.

Investors say the bankruptcy will make it more difficult for cities and towns everywhere to raise the money they need to build bridges, schools and other infrastructure. It will also hurt municipal bonds held by individual investors.

There are more than $1 trillion worth of bonds at risk, said Peter Hayes, head of municipal bonds at BlackRock. He said there will be a ripple effect nationwide.

Related: What's next for Detroit

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Orr said that the city needs to cut debt to restore services and lower costs, such as taxes and insurance, which he says have chased businesses and residents out of the city.

Detroit's population has fallen 28% since 2000. The unemployment rate, while down from a peak of 27.8% in the summer of 2009 -- when General Motors (GM) and Chrysler Group were going through their own bankruptcies -- is still at 16.3%, nearly twice Michigan's statewide average.

While the auto industry has enjoyed a resurgence with strong car sales and profits, most of the industry's Michigan plants lay outside of city limits.

-- CNN's Poppy Harlow and CNNMoney's James O'Toole and Aaron Smith contributed to this report.

Are you a Detroit city employee or retiree? We want to hear your story. Please contact CNNMoney.
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