The DPS Bailout – An Alternative History Under Bankruptcy

A Bankruptcy Postponed Is Not A Bankruptcy Avoided

US Bankruptcy Court ImageThe $ 617 million PA 192 – 197 bail out package signed by Governor Snyder on 21 June (plus the $ 48.7 million emergency down payment earlier this year) will not fix the Detroit Public Schools. The culture of corruption and incompetence long fostered within DPS suggests that the new DPS – same as the old DPS, except for some liabilities – will fail miserably a few years hence in an avalanche of new liabilities. Michigan will then be left to sort out two separate DPS entities with unsustainable liabilities. This could easily occur even before Governor Snyder leaves office in 2019. Karma. Déjà vu all over again.

Governor Snyder secured the Michigan Legislature’s approval of the $ 617 million bailout by regaling them with an entirely false narrative of the aborted 1991 Richmond, CA Unified School District bankruptcy, then implying that the entire $ 3.5 billion in DPS liabilities would fall upon the taxpayers of Michigan. The Michigan Legislature’s Republicans (and our nitwit media) bought Governor Snyder’s tale hook, line, and sinker – then delivered a $ 617 million gift to DPS for its past ill behavior. The Michigan Legislature’s Democrats had the chutzpah to hold out for even more taxpayer paid goodies.

There was another, better option: bankruptcy.

Governor Snyder’s tales of impending doom successfully derailed any consideration of forcing a DPS bankruptcy filing in the Michigan Legislature, but a DPS bankruptcy is still worth scrutiny given that the Governor’s bail out will return DPS to local control. Local control means the same political charlatans who wrecked public education in Detroit in the first place will be back in control. Those charlatans are already acting up and the time honored DPS culture of corruption and incompetence will reemerge with a vengeance.

Michigan’s deep state bureaucrats will point to supervision by the City of Detroit Financial Review Commission required by the bail out, but conveniently fail to note that that very same Financial Review Commission was unable to stop chicanery in City of Detroit vacant house demolition contracts. Only the FBI seems able to penetrate corruption in Detroit, and then only when it is politically correct to do so. You must conclude that Michigan’s deep state bureaucrats and their tool, Governor Snyder, hold the intellectual capacity of Michigan electors in complete contempt.

Herbert SteinBankruptcy is not a new, unproven remedy for financial distress arising from corruption, incompetence, or just plain bad luck. Various forms of bankruptcy date back to ancient Babylon and our Founding Fathers enshrined it in the U.S. Constitution. Emergency financial management and good company / bad company workouts, on the other hand, are quite recent experiments for financial distress which both only date back to 1988. These recent experiments are mostly a tactic to manipulate credit ratings – another recent financial innovation – well above reality. Great for borrowers, but not so good for creditors over the long term.  Unfortunately, these recent experiments often let the financial fun and games linger on, while bankruptcy stops them dead.   As a wise Detroit boy once said: “But if it can’t go on forever it will stop.”  How long has DPS been in financial trouble?  When will it stop?

Bankruptcy of local government units is controlled by Federal statute, specifically Title 11, Chapter 9 of the U.S. Code. Michigan is well familiar with this chapter of Federal bankruptcy law, having just put the City of Detroit through bankruptcy. Chapter 9 allows local units of government to discharge unsustainable debts and contracts, regardless of state constitutions and statutes. Precisely why the City of Detroit was filed for bankruptcy by Governor Snyder’s viceroy Kevyn Orr.

DPS has the debts and liabilities of a much larger school district, which it once was. Those debts and liabilities might be successfully serviced by a district with 100,000 students, but today’s district of 45,000 students simply cannot cope with them. Governor Snyder’s bail out lays off much of that debt and some other liabilities on a ‘bad company’ entity, but that ‘bad company’ entity has to be funded somehow. This is the rub. That ‘bad company’ entity is funded by revenues which either come from Michigan taxpayers at large or local revenue streams – either one of which would otherwise fund the educations of Detroit schoolkids. The Michigan revenues are effectively taken from all Michigan students, regardless of the tobacco settlement sophistry used to assuage the consciences of gullible Michigan legislators.  The Detroit revenues are effectively taken from Detroit students at the ‘good schools’.

Frank Kelley 2Michigan Attorney General Frank Kelley made it clear in his Opinion 4422 that school district bonds qualified under the Municipal Finance Act of 1948 (the predecessor of PA 92 of 2005) are not obligations of the State of Michigan. The State of Michigan is required to loan school districts which default on their bonds the amount in default in a procedure detailed in AG Kelley’s Opinion 4508. But none of this matters in a bankruptcy action, which is conducted under Federal law. This was clearly illustrated in the City of Detroit bankruptcy’s Plan of Adjustment, which reduced a broad range of Detroit’s liabilities with little regard for the Michigan Constitution or our statutes.  Legal Pro Tip for Governor Snyder & the Michigan Legislature: An Attorney General’s official opinion takes precedence over any legal opinion of the Governor, regardless of the size of his ego.

So what would have been the progression of a genuine DPS bankruptcy action?

The Detroit Public Schools would be under the control of an Emergency Financial Manager in accordance with the Local Financial Stability and Choice Act of 2012. DPS was under the control of an EFM operating under the aegis of PA 436 of 2012 when the PA 192 – 197 bail out package was passed. PA 436 specifically empowers an EFM to file a bankruptcy petition for an ailing school district and the Michigan Court of Claims created by PA 164 of 2013 would not engage in the foolishness of Ingham County Judge Rosemarie E. Aquilina, which nearly derailed the City of Detroit bankruptcy.

DPS would be temporarily protected by the automatic ‘bankruptcy stay’. This injunction would halt all creditor actions against DPS, and any new loans to DPS would have the special status of debtor-in-possession (DIP) financing. The State of Michigan would be in effective charge of the bankruptcy filing through the DPS Emergency Financial Manager. The State of Michigan would also be a creditor, but only to the extent that DPS has outstanding loans from the State School Loan Revolving Fund.

At this point, the DPS EFM would begin negotiating with the various creditors of DPS, as well as DPS employees and retirees. The State of Michigan’s total exposure as a creditor would be in the vicinity of the $ 195.88 million DPS owes to the State School Loan Revolving Fund, as noted in DPS’ 2015 CAFR on page 91. Nothing more. Nothing close to the $ 3.5 billion prevarication of Governor Snyder. And well less than the $ 617 million spent in the PA 192 – 197 bail out.

The Emergency Financial Manager could ask the U.S. Bankruptcy Court to force the State of Michigan to loan DPS funds under PA 92 of 2005 or the PA 436 Local Emergency Financial Assistance Loan Board (ELB), but under a bankruptcy stay such loans would be entirely unnecessary. All creditor claims against DPS would have been fully enjoined. DPS would continue to receive all the revenue it presently receives, without the bleeds which have crippled its finances.

Michigan AG Opinion 4422 makes it clear that DPS debt is not an obligation of the State of Michigan. And every Official Statement of DPS debt issues warned the bond holders of this fact.  They even reprint Opinion 4422 verbatim in every Official Statement.  Here is the additional warning in DPS’ Series 2009B Bond Official Statement, as it appears on Page 10:

Any amount paid by the State Treasurer as described in the preceding paragraphs will be deemed a loan made to the School District pursuant to the requirements of said Article IX. Section 16. of the State Constitution. Registered owners of the Bonds may attempt to obtain a money judgment against the School District for the principal amount of the Bonds or interest not paid when due and may periodically attempt to enforce the collection of the money judgment by requiring the tax assessing officers for the School District to place the amount of such judgment on the next tax rolls of the School District. The rights of the holders of the Bonds and the enforceability thereof are subject to bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and other similar laws affecting creditors‘ rights heretofore or hereafter enacted and their enforcement also may be subject to the exercise of judicial discretion in appropriate cases. See also APPENDIX A: “STATE QUALIFICATION” for the relevant excerpt from the State Constitution and for the statute creating the School Loan Revolving Fund and the related opinions of the Attorney General of the State of Michigan.

APPENDIX A: “STATE QUALIFICATION” is a restatement of Article IX. Section 16 of the Michigan Constitution, PA 92 of 2005, along with AG Opinions 4422 & 4508. The real money shot occurs on page E-2 of the DPS Series 2009B bond Official Statement, the second page of the cobond counsel’s opinion:

The rights or remedies of bondholders may be affected by bankruptcy, insolvency, fraudulent conveyance or other laws affecting creditors’ rights generally, now existing or hereafter enacted, and by the application of general principles of equity, including those relating to equitable subordination.

All of the outstanding DPS bond series Official Statements have similar language. The investors were warned, both that the DPS bonds are not Michigan obligations and that the bonds are subject to the usual vagaries of bankruptcy. The U.S. Bankruptcy Court would not disagree.

Any Michigan loans to DPS after a bankruptcy filing would also have the special status of debtor-in-possession financing. DIP financing is senior to all other debt, securities, and liabilities. The State of Michigan would eventually get paid in full for any DIP financing provided during a bankruptcy, unless it made a political decision to forgive such loans.

The Bottom Line

After a DPS bankruptcy filing:

  • The State of Michigan’s total exposure as a creditor would be the $ 195.88 million DPS owed to the State School Loan Revolving Fund. Not $ 3.5 billion.
  • Creditors would suffer losses on DPS bonds, just as they did during the City of Detroit bankruptcy. They were warned of this possibility in the Official Statements.
  • A genuinely new, ‘good company’ public school system would be established which would be entirely free from from the taint of the old DPS.
  • All Michigan and Detroit tax revenues intended for the education of Detroit children would go to the education of those children. A stark contrast to the multiple bleeds in the PA 192 – 196 bail out.
  • DPS employees would suffer the loss of unfunded other post employment benefits (OPEBs), and possibly some pension benefits. This is already going to happen under the PA 192 – 196 bail out, just no one has had the courage to tell the victims yet.
  • All school districts’ PA 92 of 2005 bonds would get intense scrutiny from the financial markets in the future. This sounds horrible at first blush, but Michigan politicians have not been able bring wayward Michigan school districts into line due to political considerations. It is well past time to expose all Michigan school districts to nonpolitical authority. Well managed school districts would benefit and the poorly managed districts would have to end their political obfuscation.

Epilogue

Do you still doubt that a Chapter 9 bankruptcy filing is better than the PA 192 – 197 bail out? The good company / bad company arrangement imposed by the PA 192 – 197 bailout has already resulted in Moody’s downgrading the debt sequestered in the ‘bad DPS’ hulk. The status of that debt is in serious doubt now that it is not the liability of a functioning school district. The status of that debt was changed by Michigan statute, without the Federal authority of a U.S. Bankruptcy Court. Creditors will challenge the authority of PA 192 – 197 to change the status of DPS’ bad company bonds if anything goes wrong (and it certainly will), but they would not be able to challenge the authority of the U.S. Bankruptcy Court if it discharged this same debt.

The PA 192 – 197 DPS bail out only protects the taxpayers of Michigan if the new DPS miraculously defies past history and becomes an exemplary school district. Does anyone seriously believe that this is likely? Michigan statutes unilaterally dictating remedies for underfunded government employee OPEB deficiencies, such as PA 75 of 2010, rarely pass legal muster. Only the U.S. Bankruptcy Court has such authority. Only bankruptcy can assure a decent future for Detroit’s schoolkids.  And only bankruptcy eliminates all those pesky surprises in DPS accounting which we have had this year.

IMG_5859Governor Snyder evaded bankruptcy in the case of DPS because the DPS owns no crown jewel like the Detroit Institute of Arts. Most of DPS’ physical assets can best be described as blight.  The jeopardy posed to the DIA in Detroit’s bankruptcy made it possible to shake down Southeastern Michigan charities and foundations on behalf of Detroit. Governor Snyder was comfortable with the City of Detroit bankruptcy because he knew that it would not impinge on Michigan’s credit ratings. But a DPS bankruptcy without charity gifts would have brought various Michigan credit ratings into question.  And those foundations and charities are pretty well tapped out after Detroit.

Credit ratings are earned, and should not be artificially manipulated. Bankruptcy would have clearly provided a more secure future for DPS, its students, and the State of Michigan. Ultimately, Michigan’s many different government unit credit ratings would also have been more secure, and founded on reality.

A DPS bankruptcy will happen, but later rather than sooner.  And everyone will be poorer for it.

You Betcha! (10)Nuh Uh.(0)

  9 comments for “The DPS Bailout – An Alternative History Under Bankruptcy

  1. JD
    July 13, 2016 at 1:46 pm

    Great piece with the following exception.
    I have a problem with the often pushed narrative that ANY charity or foundation in this state (let alone 'for profit') was "shaken down" for absolutely anything during Detroit's behind-closed-doors orchestrated (cough) 'bankruptcy' proceedings.

    If this is true, what entity 'suffered' the most in terms of either losing high-salaried employment numbers..not to mention LESS tax-exempt dollars extracted from Michigan taxpayers (federal, state or local) since..vs more?

    The total amount of funds deposited in ANY of these various 'non-profit' accounts at any given moment (LESS salaries, pensions and benefits) means absolutely nothing to those running them just as long as the FIRST dollar in is spent accordingly (forever) thereafter. Whatever is 'left over' compromises the mission **and said mission need not be funded at any other measurable performance level**.
    Retired professional volunteers aren't training the disadvantaged to reach a certain level of managerial or skilled proficiency and then cutting them loose to the real world so as to maximize donation spending power or the mission itself. Most of these lifelong 'do-gooders' are crafting sickeningly overpaid (cough) 'careers' begging poverty for everybody but themselves. Most large donors having any common sense have known this for decades yet value optics over the exceedingly more difficult 'teach a man to fish' model.

    Detroit's 'bankruptcy' was no different than Flint's crippling or (now) the fiasco that is DPS in terms of those perpetually fashioning 'careers' around human crisis.

    Being "shaken down" was more about even more consecutive years of guaranteed income for a chosen few who should have never received it in BOTH the profit and non-profit sectors. Anything contrary to that statement infers a public "auction" for those very public assets which was never held or (heaven forbid) so much as suggested.

    Again, great article as usual (thank you!).

    You Betcha! (1)Nuh Uh.(1)
  2. JD
    July 14, 2016 at 7:43 am

    "..DPS employees would suffer the loss of unfunded other post employment benefits (OPEBs), and possibly some pension benefits. This is already going to happen under the PA 192 – 196 bail out, just no one has had the courage to tell the victims yet.."

    ...which is why the state constitution needs to be changed so that even pension benefits 'outside' of the OPEBs are fair game as well to protect the financial integrity of the entire state moving forward. This 'blasphemy' according to even 'fiscally responsible' Tea Partiers over the past 10 years effectively destroyed any credibility that a 'conservative' movement might have enjoyed otherwise. It is and has been our children's #1 critical issue for decades and the Gadsden fliers ignored it intentionally.

    Remember that we have young people working in public service today for MUCH less at careers made infinitely more difficult and certainly less predictable by those 'still' expecting the world in return for the worst supervised/lavishly endowed public career paths in the history of man.

    Any deviation from this intentionally designed path (PA 192-196 be damned) will result in similar stormings of legislative sessions or even opposing 'tents' to effectively send the same violent message that was sent during the lame duck of 2012.

    If we aren't willing to go after what is already legally exposed (OPEBs or by far the largest portion of of our unfunded liabilities) we will never be able to look our children in the eye as we ask that they perform the same work (or by today's headlines..worse).

    You Betcha! (0)Nuh Uh.(0)
  3. Sue Schwartz
    July 15, 2016 at 9:23 am

    Once again 10x25MM, thank you. The most important statement is: "You must conclude that Michigan’s deep state bureaucrats and their tool, Governor Snyder, hold the intellectual capacity of Michigan electors in complete contempt."

    The scheme has always been to drain Michigan beginning with the EM appointment of a "retired" bankruptcy judge. This gave the appearance of his possessing some sort of special knowledge to keep Detroit out of bankruptcy--when his only special knowledge is bankruptcy. Next the legislature, pretending to bail out DPS using the mantra the "MI Const. made me do it". Adding to the tap-dance is the FBI on a mission to find corruption--'cept the corruption found went on ten years or more. Them there CPA's getting paid big bucks to add and subtract negatives never finding misplaced public funds for ten years, has me in awe.

    All the above simply proves that there are no intellectuals in government, just puppets given catch phrases by puppeteer bureaucrats (PB). The PB's pretend to give some sort of authority for legislative bad acts, giving feel-good cause to all bad actors under some blanket immunity gobbley gook. The real contempt is they're all getting paid with our $$. I want my money back.

    The solution is and has been bankruptcy. My intellect tells me there's some secret reason why this hasn't been done already. I'd say follow the money--but I suspect doing so will lead back to the Granholm/Engler eras. Anyone notice how quickly they fled the state? Just say'n

    You Betcha! (0)Nuh Uh.(0)
    • JD
      July 17, 2016 at 9:48 pm

      ".. The solution is and has been bankruptcy.. My intellect tells me there's some secret reason why this hasn't been done already.."

      It wasn't done due to two facts (especially here in Michigan):

      Nobody willing to admit that the car companies NEEDED to fail right alongside the banks, insurance companies, underwater homeowners and countless others...

      ...a FAKE geriatric grassroots 'conservative' political movement that never believed in much else than saving their own arses (no bankruptcies whatsoever or wherever) at the expense of their very own grandchildren.

      It doesn't matter what happens in government or business if ANY legitimate threat to either's power over future generations and their rightful treasure is never real nor ever intended to be.

      They only needed 10 years to (all) ride off in to the sunset unmolested and they corruptly managed to make history doing it without a single fight of any consequence.

      You Betcha! (0)Nuh Uh.(0)
  4. JD
    July 17, 2016 at 11:12 pm

    ...let not one Michigander talk 'bankruptcy' as the solution (now) with a straight face.

    Any child reading this (later) in the context of what every single one of us KNEW needed to happen well 'before' even George W claimed this was all simply a "rough patch"...will do the laughing (or more appropriately crying) for us should we dare.

    You Betcha! (0)Nuh Uh.(0)

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