Gov. Rick Snyder: Bondholders Should Have Seen Detroit's Bankruptcy Coming

By Barbara Hollingsworth | July 22, 2013 | 1:42 PM EDT

Man walks past graffiti in Detroit (AP photo)

( -- Michigan Governor Rick Synder said Sunday that investors who bought Detroit’s municipal bonds should have known the city was in deep financial trouble.

Appearing Sunday on CBS’ “Face the Nation,” Snyder told host Bob Schieffer that the state cannot bail out Detroit, which became the largest municipal bankruptcy in U.S. history last Thursday. But the governor added that the bankruptcy has been “60 years in the making,” adding that bondholders are “going to be part of this process.”

“And realistically, if you step back, if you were lending to the city of Detroit in the last few years, didn’t you understand there were major issues and problems?” Snyder said. “Look at the yields they’re obtaining compared to other bonds. They were getting a premium….Basically, Detroit hasn’t had a positive fund balance since 2004 in its general fund. 2004. So this isn’t a recent concern.”

Unlimited tax general obligation municipal bonds (ULTGO) have long been considered good investments because of their tax-free status and the fact that they are secured by a jurisdiction’s pledge to raise taxes as high as necessary to pay off investors.

However, Kevyn Orr, hired in March as emergency manager to restructure Detroit’s $18.5 billion debt (half of which is for pension obligations), has proposed paying General Obligation bond holders less than 20 cents on the dollar.

Credit rating agencies Fitch, Moody’s and Standard and Poor’s have all said they will review their recommendations if the bankruptcy judge allows Detroit to treat municipal bondholders the same as unsecured creditors.

In June, Detroit’s general obligation bonds were downgraded to junk status in anticipation of the bankruptcy filing.

In a statement released last Friday, Fitch noted that “there has been little precedent for the classification of ULTGOs as general unsecured debt and the bankruptcy court’s treatment of this issue will inform future credit analysis of ULTGO.”

So the fallout from the Detroit bankruptcy could be felt nationwide as investors reevaluate the risks and rewards of purchasing municipal bonds.

“If the unlimited tax GO bonds are not paid in full, and instead treated similarly to creditors that we feel have less security, such as pensions and healthcare benefits, then we have to re-evaluate that tax pledge.” Fitch analyst Amy Laskey told the Financial Times.