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How Detroit’s Bankruptcy Plan Is Affecting Municipal Bondholders on Wall Street

Posted on 12/06/2014

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Magii Inc., one of New York's most renowned wealth-management firms, specializes in helping businesses and individuals generate and maintain financial prosperity. The company explains how Detroit's bankruptcy plan is impacting municipal bond investors.

At its core, successful wealth management relies on investing in strategies that generate profits. Some investors turn to municipal bonds. States, cities and counties issue municipal bonds to bondholders for an upfront capital investment. Over time, investors receive payments that include principal interest and principal return.

In Detroit, municipal bond investors have suffered tremendous losses following the approval of an $18 billion bankruptcy plan. As a result, investors across the country are concerned about municipalities filing bankruptcy.

When a federal judge approved the plan, the decision set a legal precedent involving bankruptcy plans for municipalities. Ultimately, public worker pensions receive higher priority than bondholders. In the end, Wall Street creditors who invested in these bonds suffered huge financial losses.

As the United States continues recovering from the Global Financial Crisis (GFC), most investors are confident that this is not the last time a municipality declares bankruptcy of this nature. Following this case, it is likely that creditors who hold bonds worth millions will lose out to pension funds.

The reason for this is that the primary focus of bankruptcy cases is to prevent the accumulation of more debt. Removing pension funds could lead to substantial debt among retirees and public workers who depend on pension payments.

In Detroit, water, sewerage and property tax bondholders had to make sacrifices. In the end, some of these bonds were refinanced at a much lower cost, ensuring investors lost money.

The conclusion of the case implies that general fund obligations of a municipality are second to pension liabilities. Under the bankruptcy code, municipalities have more leeway to treat creditors disparately than in a case involving corporate restructuring. This may lead municipal bondholders to reconsider their investments.

Magii Inc. is a wealth management and retirement advisory firm for successful business executives and near retirees who desire financial peace of mind. Magii is located in Long Island, N.Y. and serves clients in New York, New Jersey and Connecticut.

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