(Bloomberg) — Detroit, the biggest U.S. municipality in bankruptcy, challenged the legality of a series of financial transactions behind $1.44 billion in pension bonds and asked a judge to let it stop making the payments.
The contracts, signed in 2005 and 2006, were a “sham” designed to circumvent a Michigan law capping how much debt cities could incur, the city said yesterday in a complaint filed in U.S. Bankruptcy Court in Detroit.
Those contracts allowed two city service corporations to issue so-called certificates of participation to fund pensions for municipal workers. Detroit officials at the time decided the contracts didn’t need to be considered debt for purposes of the state cap, according to court papers.
“City officials turned a blind eye to the requirements of state law and to the city’s desperate financial condition,” according to the complaint. The transactions “were nothing more than borrowings by the city of Detroit, thinly disguised as a back-to-back series of contract payments.”
When Detroit’s emergency financial manager, Kevyn Orr, put the city into bankruptcy in July, he cited the pension debt and a related set of interest-rate swaps as contributing to the financial crisis. Detroit listed $18 billion in liabilities in its bankruptcy filing and said it could no longer meet its financial obligations and still provide basic services to the city’s 700,000 residents.
“This deal was bad for the city from its onset despite reassurances it would adequately resolve the city’s pension issues,” Orr said yesterday in a statement. “We have tried without success to negotiate a resolution to this dispute and to allow the city and its taxpayers to move forward and unwind these illegal transactions.”
Before filing the suit, Detroit had given Bank of America Corp. and UBS AG until yesterday to say how much they would accept to cancel the swaps connected to the pension debt, a person familiar with the talks said. Those swaps, originally designed to protect against rising interest rates, have cost taxpayers more than $200 million since 2009.
U.S. Bankruptcy Judge Steven Rhodes last month rejected as too costly a proposal to pay $165 million to cancel the swaps and told the city to seek a better price.