Thursday, June 6, 2013

6/6/2013: Detroit is about to go bankrupt... differently from the Irish banks

So who is to say sovereign (or rather quasi-sovereign) defaults are a rarity in fiscal + currency unions? Here's a story about forthcoming, well-flagged in advanced Chapter 9 bankruptcy for Detroit:

And, guess what - the story is telling in more than just one context. The terms and conditions of the restructuring will be ugly, but manageable... And the sequencing of events is revealing:
  • Step 1: Detroit had $15.7 billion debt load it cannot repay - diagnosis was set as insolvency. 
  • Step 2: The city was taken over by the state of Michigan and emergency manager was appointed.
  • Step 3: The state of Michigan needed a calm evaluation of the problem confirming the diagnosis of insolvency and it was deemed to be structural (economy suffering from unsustainable levels of unemployment, declining population, loss of revenues, etc, but also cost overruns).
  • Step 4: Rating agencies dropped ratings on Detroit debt and debt limits kicked in before then.
  • Step 5: Chapter 9 bankruptcy, forced deal with the unions and Financial Advisory Board was set up with very clear termination objectives.
The sequencing of events above is distinct from what has happened in the case of Ireland's banking crisis resolution, where the above steps were re-ordered as follows:
  1. Steps 4 and 5 (resolution steps) took place ahead of any assessment and diagnosis postulation and confirmation (banks guarantee issuance)
  2. Step 3 took place next in the form of PCARs assessments
  3. Step 2 (takeover) took place only after the PCARs
  4. Diagnosis was never fully correctly established - all banks, save for Anglo and INBS are still considered officially solvent
  5. Step 5 never took place with exception of Anglo and INBS
In other words, we never created a security cordon around the banks that would have resulted in banks takeover prior to guarantees and recapitalisations and this has meant that the banks were always able to use the threat of disclosure of insolvency as the means for bargaining out improved position vis a vis the taxpayers. 

Best proof of this: at no point in time did the state of Michigan tell the markets or the nation or its own taxpayers that Detroit will never be allowed to go bust. In contrast, during 2008-2010 period, Irish Government repeatedly asserted that the banks will be provided all and any funding necessary to stay in business. 

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