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By Jeremy Glaser and Elizabeth Foos | 06-25-2013 11:00 AM

Will Detroit's Muni Breakdown Force Others Off the Road?

The outcome of the Detroit's distressed-debt situation could be a litmus test for how other municipalities nationwide move forward with their payment obligations.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Detroit's on the brink of bankruptcy, but what does that mean for the broader municipal market? I'm here with Beth Foos, a municipal credit analyst here at Morningstar, to take a look at some of these questions.

Beth, thanks for joining me today.

Beth Foos: Thanks for having me.

Glaser: So, let's take a quick look back at Detroit's fiscal picture and how they kind of got up to this brink. What's happened recently there?

Foos: Well, it's well-known after decades of budget deficits and an eroding tax base and economy and basic mismanagement, the State of Michigan appointed an emergency manager, Kevyn Orr, back in March of this year to basically take over the majority of the operating and financial functions of the city. So, Orr came in and did his own financial and operational review of the city and called the city insolvent and said it couldn't possibly pay its nearly $19 billion worth of liabilities.

So, a couple weeks ago he called all the city's major creditors back to the negotiating table and unveiled a sweeping and pretty controversial plan to restructure all of that debt. And on the same day, on June 14 of this year, the city missed a nearly $40 million payment on some pension-obligation certificates.

Glaser: So, what are some of the broad strokes of that restructuring? Anything surprising there?

Foos: There was, and I think the key point to note is how Orr treated, what he called, secured debt and unsecured debt. And the unsecured portion is really something to watch. That's $11.4 billion worth of general-obligation unlimited tax debt, limited tax bonds, pension-obligation certificates, unfunded pension liabilities, and retiree health care, and what he's proposing is to exchange all of that for $2 billion worth of notes.

So, with that treatment, he's treating what is generally considered some of the most secured debt in the state, if not the muni market, that general-obligation unlimited tax pledge, which is voter-approved, and a dedicated property tax levy, on par with what's considered much lesser secured debt, those unfunded pension liabilities, those retiree health-care liabilities.

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