With swaps deals, Detroit's best interests in question

Dealt a fair hand?

With swaps deals, Detroit's best interests in question
Photo by Curt Guyette.

Detroit Emergency Manager Kevyn Orr sat on the witness stand last Thursday, trying to convince U.S. Bankruptcy Judge Steven Rhodes that he’d bargained hard to get a good deal for the city, and had been prepared to file a lawsuit against two banks if they didn’t bend to his will. 

And bend they did, he said.

Two attorneys from Jones Day, the law firm where Orr formerly worked, and which now works for him helping to restructure the bankrupt city, told the judge that the deal they hoped to close was truly in Detroit’s best interest.

Nearby sat an attorney representing Bank of America/Merrill Lynch, a Jones Day corporate client that has signed a waiver allowing the firm to represent Detroit as long as Jones Day doesn’t assist the city in any lawsuits against the bank. He too was urging the judge to sign off on the deal.

Twice previously, the judge had been told that Bank of America and UBS, an international bank based in Switzerland with affiliates that are also represented by Jones Day, had made significant concessions regarding the $272 million they claim is owed them, and both times the judge said “no,” because, despite what Kevyn Orr and Jones Day and the bankers said, he didn’t think the deals were nearly good enough for the people of Detroit. In fact, the last time the issue was in front of him, the judge told Orr and his team that if they were to litigate instead of negotiate, they’d likely prevail.

Which is what attorney Jerome Goldberg, who represents a lone retiree, kept trying to get the judge to focus on.

The conflict has its roots in a $1.4 billion loan the city received in 2005 and 2006 to shore up the city’s pension systems. Tied to that loan were what are known as “interest rate swaps.” Essentially they were a bet on the direction in which interest rates would move: If rates went up, Detroit would reap the benefit; if they went down, the city would owe the banks.

In 2008, when the economy crashed, interest rates plummeted, and Detroit was left holding a very expensive bag. That $270 million the banks say is owed them is what it should cost the city to get out of the swaps deal, which is currently costing the city about $4.2 million a month.

That monthly payment, by the way, comes from the city’s casino tax revenue. The two banks are guaranteed their payments, making them what are known as “secured creditors. But one of the issues is that, according to Judge Rhodes, it is quite possibly an illegal deal, because state law dictates what those casino taxes can be used for, and paying off a bad bet made with banks isn’t one of them. Oddly, though, Orr and Jones Day and the banks, which have agreed to settle the swaps for $85 million, are asking the judge to allow that money to be paid back with … casino revenue.

Carole Neville, an attorney representing retirees, objected to the settlement last week on the basis that Judge Rhodes has already said it appears to violate state law.

For Goldberg, though, the absurdity goes even further. A longtime activist who has helped fight against home foreclosures, both in the courts and in the streets with the group Moratorium Now, he sees any payout to the two banks as morally repugnant. 

Goldberg pointed out that the Federal Deposit Insurance Corporation filed suit in March against 16 major banks, accusing them of illegally manipulating interest rates, earning massive profits from swaps and similar deals by keeping interest rates artificially low. Bank of America and UBS are among the banks being sued; UBS and several other banks have already agreed to pay out some $6 billion to resolve the charges, according to published reports.

Goldberg argued that it’s not just the guarantee of the casino taxes to the banks that is illegal, but the underlying swaps deal itself that is invalid. The judge has agreed that if the city were to file suit claiming that, it would likely prevail. And, it is assumed, that’s one of the things the lawsuit Orr said is ready to go would hope to accomplish.

Orr, Jones Day and the banks keep pointing to the $272 million that Bank of America and UBS say they are owed in order to show how much the city is saving by only having to shell out $85 million to get out of the disastrous deal. Goldberg, on the other hand, continues to keep reminding the court that, if the city were to sue the banks and win, not only would it have to pay nothing, it could potentially recoup the $300 million it has already forked over since 2009.

Pursuing that route, Orr and Jones day contend, is far too risky. The city couldn’t afford to lose. And so the negotiated settlement is the most prudent course.

Last week in court, with Orr on the stand, Goldberg asked if the emergency manager thought the original settlement of $230 million was a good deal for the city when it was presented to the judge. “Yes,” replied Orr. And the second settlement of $150 million? Did Orr also think that was a good deal for the city when it was presented to the court? “Yes,” he answered.

Twice before, Judge Rhodes has protected the city from Orr’s apparently bad judgment regarding what constitutes a good deal, and those rulings helped bolster the faith of Detroiters that there is someone who is truly looking out for their best interests, Goldberg told the judge.

Now it is again up to the court to decide:

Is this latest deal truly a good one for the people of Detroit?

Curt Guyette is an investigative reporter for the ACLU of Michigan. His work, which focuses on emergency management law and open government in Michigan, is funded by a grant from the Ford Foundation. You can find more of his reporting at aclumich.org/democracywatch.