BOOK EXCERPT How Wall Street enabled Detroit’s collapse
New book details the creative — and possibly illegal — deals that led to its bankruptcy
In 2013-14, Detroit’s financial implosion cast bondholders, pensioners and city residents against one another in the largest municipal bankruptcy in U.S. history. USA TODAY Money reporter and former Detroit Free Press journalist Nathan Bomey’s new book, Detroit Resurrected: To Bankrupt
cy and Back, released Monday, tells the dramatic story of a great American city struggling to overcome $18 billion in debt. This excerpt, adapted with permission from New York-based W. W. Norton & Co., depicts the story behind a disastrous $1.4 billion debt deal that crushed Detroit’s budget.
With variable-rate, no-downpayment mortgages being distributed to homeowners at a frothy pace in the 2000s, it’s not surprising that Wall Street rushed to lend money to what was arguably the nation’s most financially distressed city.
Detroit was like a homeowner who couldn’t afford to pay. But that was irrelevant to the dealmakers. Their principal concern was not whether Detroit could af- ford the debt payments. Their concern was the city’s legal capacity to borrow.
By 2004 — after its population had plummeted from a peak of nearly 2 million in the 1950s — Detroit was tapped out.
Mayor Kwame Kilpatrick wanted Detroit to borrow $1.4 billion to fund pensions — even though the city could legally borrow only $600 million before hitting Michigan’s debt limits.
This inconvenient fiscal reality spurred a legion of powerful lawyers and Wall Street advisers to create a byzantine new structure to make the deal possible.
With the city unable to issue any more traditional bonds, Kilpatrick in November 2004 proposed creating two shell corporations to do the deal. He threatened thousands of layoffs unless City Council approved the transaction.
The concept was actually quite simple. Kilpatrick and the City Council took out a jumbo mortgage, gave the sparkling mansion — in this case, a pile of cash — to their politically connected friends and kept the debt obligation.
It was a classic pass-through structure. The city would create new legal entities to issue the debt, making it appear like the shell corporations actually owed the payments. But in reality, the city would always be on the hook for the payments.
If it smells like debt and looks like debt, it is debt.
Two bond insurers — Financial Guaranty Insurance Company (FGIC) and a company that later became known as Syncora Holdings — wrapped the certificates in insurance that would pay out to bondholders in the event of default.
By any measure, it was an inventive transaction. The cash raised through the deal was split between the city’s two pension funds. The so-called certificates of participation effectively promised debt holders a piece of Detroit’s cash flow — with fixed interest rates of about 4% to 5% on $640 million of the certificates and a variable rate on the other $800 million.
To address the possibility of interest rates rising, the city locked in a steady interest rate on the $800 million in variablerate certificates. To do so, it purchased interest-rate swaps from global banks Merrill Lynch and UBS, effectively obtaining a fixed rate on the transaction and creating more predictability for the city budget.