Art and creditors: Tactics from Detroit’s debt mediator

Written by  //  April 20, 2017  //  General Biz News  //  No comments

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Some consider Detroit Industry as the best example of Mexican mural art in the United States, and the artist identified the piece as the best work of his career.

By Carla Minet and Joel Cintrón Arbasetti
Center for Investigative Journalism

The Detroit Industry mural of the Mexican painter Diego Rivera rises magnificent, grandiose, at the atrium of the Detroit Institute of Arts (DIA). Inspired by the dynamics of a Ford factory, one of the most important automobile companies in the city, the monumental fresco of 1933 depicts, in four 360 walls composed of 27 panels, the workers of the auto industry surrounded by mechanization in production lines, monitored by managers, in contrast to indigenous figures and scenes exploring great human and capitalism dilemmas from Rivera’s Marxist stance.

Some consider Detroit Industry as the best example of Mexican mural art in the United States, and the artist identified the piece as the best work of his career. It is the most striking work in a collection of 66,000 creations, which includes the acclaimed van Gogh, Renoir, Cézanne, Degas, Rodin, Warhol and Miró.

Valued in $8.5 billion, the DIA collection was in danger of being sold to pay Detroit’s public debt, and after court battles and a fundraising marathon that ended in a deal called The Grand Bargain, is now protected in a public trust, a legal move that gave breathing air to the city pension system.

Detroit was bankrupted four years ago and today appears to show signs of fiscal recovery. At least the balance sheet looks like it, even when the poverty and the dilapidated houses slap your face when you leave downtown. Over the last two years population has increased in Detroit, for the first time in decades. And city revenues are increasing.

One of the creators of the deal that saved the DIA collection was Gerald Rosen, a former Judge of the United States District Court for the Eastern District of Michigan. He was also the debt negotiator for the city of Detroit, whose job was to bring the parties together and come to an agreement.

There were 150,000 creditors, divided into groups such as those formed in Puerto Rico to claim payment of the debt. Among them were hedge funds and exactly the same bond insurance companies that are in Puerto Rico.

Rosen negotiated with everyone at the same time, “although not always in the same room,” he said by the end of February at a table in the Rattlesnake Club in Detroit, where he spoke with the Center for Investigative Journalism.

Some negotiations with creditors took eight months and some more than a year.

“Judge Steve Rhodes and I understood that the only way to get through the bankruptcy quickly to the other side was through consensual agreements. Because otherwise the bankruptcy would go on for years and the city would be fighting its employees, its police officers,” Rosen said.

Detroit is not similar to Puerto Rico, but there might be lessons to be learned. Especially in the prelude to voluntary negotiations initiated secretly last week in New York City by the Puerto Rico Fiscal Oversight Board and the government with creditors.

Did Detroit have different kinds of debt?
We had several different, more than several, a number of different kinds of creditors, much like Puerto Rico. We had what’s called UTGO (Unlimited Tax General Obligation) debt, we had LTGO (Limited Tax General Obligation) bonds, we had Special Revenue Debt (for the Water Department), and within each of those categories, there were separate kinds of issuances. And then we had what was called COPs (Certificates of Participation, which funded the pension underfunding in 2005 and 2006), and on top of that we had what was called swaps (instruments that hedged against rising interest rates).

We heard there were around 150,000 creditors.

Yes. In addition to the institutional debt, the bonds, then there were the retirees, and then there were vendors, people who sold to the city, and people who had gotten judgments against the city. We negotiated with all of them.

Did they form groups?
Yes, we negotiated. For example, within the UTGO, there were four different insurers, which insured four different kinds of issuances. And they formed groups for negotiation. We would negotiate with the UTGO’s, generally we would do it as a group, they had lead lawyers for each group, and a lead financial person, so we negotiated with them.

How long did it take?
It differed for each group of creditors. The first deal that we reached with the UTGO’s, we started negotiating in August, and finished in March. For the LTGO’s we reached an agreement pretty soon after that, and the Special Revenue Bonds came much later in August. The COPs were the last, in October. The swaps were done by March also.

Did creditors go to court before the bankruptcy was declared?
The COPs did. They were the only ones. I know in Puerto Rico there have been lots of lawsuits: the COFINA, the GO’s lawsuits…

When you were interviewed in Puerto Rico, you said that the causes for the bankruptcy in Detroit were bad fiscal management and population loss.

There were lots of underlying causes. Population loss was very important. Detroit back in the 50’s was a city of 2 million people, and it’s now 700,000. When population leaves, revenue leaves.

But was population loss a cause or a symptom of the crisis?
It’s kind of a self-fulfilling spiral that feeds on itself. The less people, the less revenue; less revenue, less services. Detroit was not really providing services to people. And the taxes were very high. Detroit had the highest tax rate in the state [of Michigan]. People were not getting anything for them.

What about unemployment, was that also a cause?
Unemployment was very high. But really, the causes were many. There were racial issues in Detroit, there always are. But I would say the primary cause was population loss, revenue loss, terrible fiscal mismanagement of the city.

Can you give us some examples of that?
They kept spending and spending with no realistic prospect that they could pay back to the people who were lending to them. For example, there was a $1.5 billion pension shortfall in 2005 and they did this COPs deal. Detroit was already in its statutory borrowing limit, and then they did this COPs deal which circumvented the statutory borrowing limit; a very complicated deal. And they just kept adding debt.

Who was making those decisions?
The mayor; and corruption played a role too. You’ve probably heard of Detroit mayor, Kwame Kilpatrick and his 40 associates, who were convicted in federal court. When I was Chief Judge, I presided over the Grand Jury that indicted them. So, corruption was a big issue.

An audit of the debt was brought at which point of the process?
Yes. Governor (Rick) Snyder did do, I think, as good an audit as he could. He appointed people, accountants and structural reorganization people, to do an audit of the debt.

One of the problems with Detroit was that there was a very bad recordkeeping, so it would certainly not have satisfied traditional accounting standards. But by the end we had a very good fix of what the debt was.

At which point did you know who were the creditors of Detroit?
That was right at the beginning of the bankruptcy. Because when the City files the petition they have to list the creditors. I was the one who put the negotiation together, which I think Puerto Rico desperately needs and nobody is doing it. I’m getting calls all the time from people in Puerto Rico, and nobody seems to be driving the bus. It will probably end up in a court-supervised process. They should be negotiating now, like we did in Detroit. I don’t know why they’re waiting.

Many of the lawyers I worked with are down in Puerto Rico. And I hear from them. I just heard from one, and some say, ‘these people are in denial, they don’t want to address the real issues’, and some just say there are political obstacles. But look, things aren’t going to get better until you address them, that’s how it goes.

Gerald Rosen

Which kind of creditors did you have in Detroit?
We had hedge funds, not to the extent that you have in Puerto Rico. Most of the financial creditor debt was insured, principally by four insurance companies.

Which ones?
The same ones that are in Puerto Rico. Assured, National, Ambac, and I don’t know if Syncora is in Puerto Rico. Is Syncora in Puerto Rico?

Yes.

Also Federal Guarantee Insurance Corporation. So I think it’s the same group of people. And obviously the insurers are the ones that are most interested in getting money back, because otherwise they are on the hook.

Did you analyze what would be the outcome if you didn’t cut and renegotiate the debt, and got a cut of 50 percent for some debt?
There would have been a disaster. We had to cut the debt, we had to restructure other debt, and we had to bring in new revenue. If we didn’t, Detroit would still be in bankruptcy. And all of the investment that is happening now, a lot of it wouldn’t be coming in. You know, investors want a stable market, and when you’re in bankruptcy, there’s uncertainty for investors.

How did you get to the 50 percent cut in some debt?
You have to go through each agreement that we reached. We ordered the agreements by the level of the strength, of the legal standing that each of the creditors had. For example, the UTGO bonds got 74 percent of their debt, because they had the strongest legal position of the financial creditors. The pensioners, they got almost 100 percent of their pensions but they lost almost 90 percent of their healthcare. Of what the total debt was for the city, on healthcare, we cut that debt, which was $7.5 billion, we cut that by 90 percent, so they really took the biggest hit on healthcare.

The LTGOs took about a 60 percent cut. The Special Revenue bonds, of the Water Department, took no cut for their principal debt; but we were able to refinance, because they were secured. We were able to refinance the Revenue Bonds, through what’s called a ‘tender offer’, which was really a reverse tender offer, and the person who designed it is working right now in Puerto Rico.

His name is David Brownstein and I hope he is successful there. He was in Detroit and he came up with this brilliant idea. And so we were able to refinance the Revenue Bonds at a much lower rate. And we saved more than $113 million initially just on that refinance.

Why do you think it’s better that a judge, someone like you or Rhodes, is making these decisions and leading the process, instead of an elected official? Because the political cost of decisions… In your case, you don’t have to face an election.
We are independent. But we are not democratic. It’s good, but it’s bad. But both, Steve and I, were very sensitive to the people, I mean, Steve invited people to the court to make statements about the bankruptcy, give testimony…

About the DIA, how did that happen?
The city had virtually no assets. None. My job was to get deals. To get deals between the creditors and the city. To get deals you have to have money or assets that can be monetized. Detroit had nothing except the art; that’s all it had, really: 42 percent of all of the city’s revenue was spent in pensions and healthcare, for retirees. And that number was increasing dramatically. In four or five years it was going to be 67 percent. So, it was pretty clear to me that somehow the art was the only asset the city had to be monetized.

On the other hand, selling the art would have been a disaster for the city. It would have been horrible. The Detroit Institute of Arts is one of the greatest museums in the world. It has 66,000 pieces of art, and one of the things I saw was it was drawing almost 600,000 people a year into midtown. And those people were coming, and in addition to going to the art museum, they were going to the shops, and the restaurants. So, to have liquidated the art, the museum, would have been like dropping a hydrogen bomb in the middle of the city. Would have sucked the economic life out of it.

And then there were racial issues as well. I mean, the art museum was raising a litigation fund to fight the liquidation, and the Board of the museum was a ‘who’s who’ of everybody in the region. So you got the unions on one side, largely African-American employees, and the retirees, with a healthy African-American population, so there was this very ugly narrative that was developing: the art versus the people. So when I came up with the idea of The Grand Bargain, it was a way of monetizing the art by bringing new money in, and then taking all of the money and giving it to the retirees.

How did the DIA employees receive that proposal?
Well, eventually, they were very supportive and they even raised $100 million to contribute; the DIA raised that from private donors, to contribute to what was called The Grand Bargain.

And the retirees?
They voted, I think 73 percent, to support it.

Wasn’t it seen like a way of privatization of public assets?
No, it wasn’t a privatization. It’s in a public trust. There were people who wanted to privatize, weather selling it piece by piece, or selling it to some sort of conglomerate, but no, that’s not what we did. We put it into a public trust.

So, the revenues from the DIA, where do they go now?
All of the revenues that come in, the operating revenues from the DIA, the money that we raised, flow through a fund for the retirees. That was how we leveraged it.

When you went to the philanthropic community to convince them to help, wasn’t there a question about why they should have the responsibility of getting all these funds to ‘save the city’, instead of the private sector that benefited from the city?

The philanthropic community helps people. And Detroit was about not just saving the art, and not just helping the retirees, but saving the city. And that was the appeal that I made to the foundations.

So they didn’t question why they should be the ones?
I’m sure they questioned. They had internal debates. The DIA raised $100 million from the private sector, from automobile, the ‘big three’ (General Motors, Ford and Chrysler), the major parts suppliers, all the major corporations in town contributed.

By the end of the conversation, Rosen gave some thought to Puerto Rico’s challenges.

“I do know that the dynamics of the situation in Puerto Rico are very similar to the dynamics of the situation in Detroit. Population loss, declining services, a stalemate politically, you have a braindrain, and yet you have an island, a territory, with great potential that’s not being realized. That’s what we had in Detroit. At a high level, there are many similarities. I think there’s hope for Puerto Rico, if people are courageous enough to address the problems. If Puerto Rico had a bankruptcy statute, or could file for bankruptcy, there would be huge progress like we did in Detroit,” he said.

“The mediation process I designed had never been done before. And a lot of people told me it couldn’t work. The team, each mediator took a group, with me in the middle… I’m not here to say Puerto Rico has to do it the same way we did in Detroit. Every territory, every city, is going to have to find its own way that is tailored to its own problems and its own history. But I will say this to anybody: it’s not going to get better,” Rosen concluded.

This story was published in part with the support of the Ravitch Fiscal Reporting Program, at the City University of New York (CUNY) Graduate School of Journalism.

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