Once Detroit announced they would be going bankrupt, almost immediately traders began making their bet. The Detroit fallout involves almost $18 billion in debt, backed by insurance holders paying out to bondholders. Detroit is struggling to fund the city’s pension system (an expense that cannot be shuttered) and the city needs to sell bonds in order to do so. And as Detroit scrambles, Wall Street is payign attention, as hedge funds scramble to buy bonds, thus becoming creditors to the beleuagured American metropolis.
It’s a big bet, but many traders thinkdespite teh city's troubles they'll be able to meet their obligations. The rush to capitalize on the bankruptcy is so frenzied that there is currently a long waiting list to buy Detroit municipal bonds.
The bond issue is further complicated by a refusal of the city to accept a bailout. Emergency city manager Kevyn Orr said “Hope is not a plan” and he has neither asked for nor been offered a bailout. But the desires of bond holders are of no interest to him, nor Governor Rick Snyder. Their only concern is “fixing Detroit.”
If the city defaults, the original bond-holers’ investments will become near worthless. Of special note are $530 million general-obligation bonds, backed by taxpayer money and thus considered safe - that is, if an entire city of taxpayers doesn’t default on them. Snyder brushed off concerns the scrambling bondholders could be left with nothing, noting that the Wall Street bond traders are “sophisticated buyers” who understand risk.
Regardless of risk, the bonds are the hottest bonds on the market right now. The bondholders who have gotten in on the trading believe Orr is being overly pessimistic on the city’s chances to meet their debt obligations.
Bullish investors think the payout will be far higher, citing the fact that cities usually pay back creditrors at a higher rate than corporate defaulters. According to municipal bankruptcy expert Jim Spiotto of Chapman and Chapman, while municipal bankruptcies usually pay out to bondholders better than corporate ones, Detroit could be a special case, because “Detroit has a long history of disappointing people.”If the city does end up paying off its debts though, the debt could be a huge win for bondholders. Orr originally put the return for bondholders at 10 cents on the dollar.
Among many austerity measures the city is considering undertaking to pay back creditors, Detroit has considered restructuring their Sewage and Waste Management system, deferring penrring pension payouts, and even selling the city’s art collection, valued at around $1 billion.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer