$18bn question: Is Detroit eligible for bankruptcy?

Those who run America’s once flourishing auto capital need to prove Detroit is legitimately bankrupt in order to restructure its $18 billion debt. Unions and pensioners, who fear losing public services, are challenging the bankruptcy.

If approved, the municipal bankruptcy would be the largest in US history.

The bankruptcy would allow Michigan’s largest city to restructure its debts and liabilities and avoid a "payless payday" . If the city continues paying pension funds, they could leave some city workers without pay checks.

An attorney representing Detroit on Wednesday urged that without bankruptcy almost 65 cents of every tax dollar would be swallowed up by debt and other obligations, the Guardian reports. The bankruptcy would allow Michigan’s largest city to restructure its debts and liabilities and apply for federal loans.

The court case marks a crucial stage since the city publicly filed for bankruptcy in July this year. 

Before filing city officials decided to cancel payments to pension funds and default on their debt, Gaurav Malhotra, a partner at Ernst & Young LLP, testified in Detroit.

In reaction to sharp cuts, unions and pensioners are taking on the city, claiming the bankruptcy isn’t legitimate. If it is Okayed, public services will be scaled back even further, which has unions worried the city won’t pay out public pensions or health-care benefits for retirees.

The hearing is scheduled to finish on October 29, and a ruling will not be issued until at least November 13, US Bankruptcy Judge Steven Rhodes said on Wednesday in Detroit.  

Michigan Governor Rick Snyder, a lawyer by training, is expected to be called to the stand on October 29, an unusual practice for a sitting governor.

Bruce Bennett, a lawyer of Jones Day, the DC-based firm representing the city will present the case that Detroit’s bankruptcy was ‘clean’ and by-the-book with creditors.

There is a “mountain of evidence” that the city is “failing to provide basic services,” Bennett, said at the beginning of the trial on Wednesday, Bloomberg reported.

AFSCME, the UAW and other unions want to convince Judge Rhodes that the appointment of Kevyn Orr, the city’s emergency manager, was unconstitutional, and therefore the city isn’t eligible for bankruptcy.

Detroit became America’s largest city to file for federal bankruptcy in July 2013, as debt mounted to the point the city could no longer pay for basic services, like trash collection.

Orr was appointed by the state of Michigan to guide the city through bankruptcy, and has a large say over Detroit’s finances. Orr, who believes Detroit is ‘tapped out’ and sees bankruptcy as the only way forward, is expected to testify on Friday.

Banks, bondholders, and businessmen haven’t launched any formal objections against the city’s filing for bankruptcy.Detroit, a steel town that blossomed into America’s automobile capital with the success of Ford and General Motors, has been in financial turmoil for years as the shrinking car industry has decreased tax revenues. A quarter of its population has fled in the last decade, as job opportunities have vanished and quality of life degraded.

City tax rates have already reached their "legal limit", so the government can’t take any more from residents to pay off its massive debt, which is nearly on par with Ethiopia’s. 

Detroit’s debt is about one-thousandth of the US total public debt, which is nearing $17 trillion.

‘Staggering corruption’

There is a strong sentiment that corruption played a large role in the mismanaging of the municipality.

Former Detroit Mayor Kwame Kilpatrick has been sentenced to a 28-year prison sentence for extorting millions of dollars, bribery, and cronyism- giving out contracting deals to family and friends. One of his friends received $127 million in city contracts during his tenure as mayor. 

"Kilpatrick is not the main culprit of the city's historic bankruptcy, which is the result of larger social and economic forces at work for a decade," federal prosecutors said in court documents. "But his corrupt administration exacerbated the crisis."