Detroit's bankruptcy bogs down when European banks dig in their heels

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Marco Werman: This next story is a great example of how our fiscal troubles here in the US can impact folks halfway around the globe. When the city of Detroit filed for bankruptcy this summer a lot of people lost a lot of money, including a group of banks in Europe. And now as the Motor City slogs through bankruptcy proceedings, there's a hitch, a little something called the European financial crisis. Journalist Tim Fernholz is connecting the dots between Detroit and Europe's fiscal woes for the online news site Quartz. So, Tim, why are European banks interested in Detroit in the first place? Tim Fernholz: Before the financial crisis, when European banks were buying all kinds of crazy things in the US like mortgage debt, they also bought a bunch of bonds from Detriot and lent them a ton of money, about a billion dollars. Werman: Which banks are we talking about? Fernholz: We're talking about banks like Dexia which is a Belgian bank, a bank called Depfa which was Irish but then was bought by Germans, the German bank Commerzbank. Probably three of four big European financial institutions. Werman: And what did they do with these bonds? Or what were they planning to do? Fernholz: They were planning to make money with them. They thought it was a great idea. They were getting a pretty good yield because of the risk involved with lending money to Detroit, but when the global economy crashed followed by the whole European financial crisis, they found themselves in a tough spot. And when Detroit entered bankruptcy earlier this summer it was even tougher and they found themselves dealing with big losses that they really couldn't afford to, especially because a bunch of these banks are now owned by national governments, which is to say they're owned by European taxpayers who don't want to take losses thanks to something happening in a city across the Atlantic. Werman: So who is actually digging their heels in now? Is it these European governments which now own some of the banks' debts? Or are the banks still solvent? Fernholz: The banks are solvent now thanks to the bailouts they got, but they are digging in their heels because they really don't want to lose any more. And a lot of people thought that the European banks would sort of just sell this debt to hedge funds who are more interested in these kinds of high-stakes negotiations and take the loss, but they sort of surprised people by marking their debt down a little bit and saying, "You know what? We're hiring lawyers who do this and we're getting involved in the fight and we're going to try and push for it and get as much money out of it as we can." Werman: So how big a loss are we talking about here for these banks? Fernholz: Well, it's one billion dollars all totaled and right now they would like to get forty-six cents on the dollar for it, about four hundred and sixty million. It doesn't look like anyone wants to give them that much money. The hedge funds will pay maybe forty cents on the dollar and Detroit will give them maybe ten cents on the dollar and it's finding some middle ground in there that's going to be the challenge over the next year or so. Werman: I mean situation I guess is just a reminder of how the boom of financial markets around the globe also spread risk around the world and I'm just wondering are we gonna see more of these Detroit-like scenarios in the future? Fernholz: Well, we have been seeing more municipal defaults in the US in the recent years thanks to the recession and the financial crisis and the housing boom for a lot of these municipalities that sort of hope property taxes would see them through and there are still a lot of people around the world who bought this debt. So I think we'll see more of these. I think as the US economy improves, as it is slowly doing, the odds will go down, but you're absolutely right. This is a crazy sort of artifact of globalization where we basically have German taxpayers fighting with taxpayers in Michigan over who is going to get the money that Detroit collects. Werman: You know, we're talking bonds and banks and hedge fund managers here. Let's step away from them and put a human face on this for a moment. Now, I've seen the pictures. I'm sure a lot of our listeners have of the neglected parts of that sad city. Who does this really impact at the end of the day? Fernholz: Well, everyone involved, but I mean for the human face you have to look at the pensioners. There's about forty-thousand retirees in Detroit who are living in this city that has made them promises it just can't keep and they stand to lose a lot, if not all of their health benefits. They are probably going to end up on either Medicare or on the new Obamacare exchanges and they stand to see their pensions reduced quite a bit as well. These are people who are living on a fixed income who could see it go down by a lot and their representatives, the trustees of these pension funds, are fighting tooth and nail in bankruptcy court to try and prevent that from happening, but it's not clear how successful they going to be with all of these other people fighting over the same sort of limited amount of money. Werman: Journalist Tim Fernholz writes for the online news site Quartz. Tim, thanks for explaining this to us. Fernholz: It's a pleasure.