eNews July 25, 2013

July 25, 2013


News Briefs

  1. Detroit Bankruptcy Likely to Languish in Court System
  2. After Chapter 9 Filing, Detroit Looks More Like Greece than Ever
  3. Report: Risk Management Increasingly Important, but Companies Struggling to Convey Its Value
  4. More Problems for the Once-Mighty BRICS
  5. Surprisingly Positive News Emerges in EU Economic, Credit Studies
  6. Senators Try to Saddle Fed with New Dual Mandate in Monetary Policy Hearing


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Detroit Bankruptcy Likely to Languish in Court System

The City of Detroit officially filed for Chapter 9 bankruptcy protection after months of speculation that quickly escalated in the days prior. But it is just the start of a highly complicated, time-consuming process, said one top bankruptcy attorney. And trade creditors should be paying attention, even if the Motor City isn't a customer of theirs.

Bruce Nathan, Esq., a partner at Lowenstein Sandler LLP, said this Chapter 9, filed July 18 by city Emergency Manager Kevyn Orr, could be "disturbing" for trade credit. Unlike the filings of smaller cities, such a major municipality entering Chapter 9 will draw more attention. Some of that attention will come from other cities with problems similar to Detroit. Pensions and other entitlements are emptying city coffers at an alarming rate throughout the country. Where creditors need to be concerned, in Nathan's estimation, is that cities that have gone through Chapter 9 proceedings also chose not to pay non-essential creditors the overwhelming majority of the time.

"Unlike in a Chapter 11, it can pay a trade creditor if it wants to at any time," said Nathan. "But I doubt they will be paid. Only a fraction of them do. If they no longer have a reason or legal obligation to pay all that they owe, why would they?"

Nathan said he believes that, if successful, Detroit's efforts will likely lead to copycat filings in other cities, where the problem could spread to more creditors. The one silver lining is that a Chapter 9 filing cannot be converted to Chapter 7 liquidation if there are problems. This is one of many ways a Chapter 9 differs from a Chapter 11.

Either way, this case could take a long time to run its course. Some of Detroit's early obstacles included suits over the constitutionality of such a filing. That was the crux of a lawsuit filed last week by the General Retirement System of the City of Detroit and Police and Fire Retirement System of the City of Detroit, but U.S. Bankruptcy Judge Steven Rhodes suspended all lawsuits that attempted to derail the filing process on July 24.

"It's going to take a long time, and it could be very messy," Nathan said. "You're dealing with the lives of retirees. Look at how long Jefferson County, Alabama took, and it had nowhere near this complexity."

- Brian Shappell, CBA, CICP, NACM staff writer

Chapter 9: Coming to a Municipality Near You

Detroit's Chapter 9 filing won't be the last! Our troubled economy continues to harm many municipalities.

Catch this Chapter 9 teleconference presented by Bruce Nathan, Esq., partner at Lowenstein Sandler LLC, on October 7 for the causes of the financial distress, how Chapter 9 works, how trade debt is treated and more.

For other upcoming legal education offerings, check out the NACM Events Calendar.

After Chapter 9 Filing, Detroit Looks More Like Greece than Ever

Detroit's financial struggles were no secret, nor was the 50/50 chance it had of filing a Chapter 9. Still, although some have covered the growing threat of cash-strapped municipalities for the last three years, Detroit's record Chapter 9 case has suddenly shined a spotlight on this rarely exercised portion of the Bankruptcy Code, starting with media outlets and extending to the Administrative Office of the U.S. Courts, which, a day after Detroit filed, released a free guide on its website, simply titled, "When Cities Go Bankrupt."

The largest Chapter 9 filing in U.S. history has also thrown the similarities between Detroit and Greece into sharp relief. Both have been held up as poster children for post-recession municipal and sovereign debt struggles, but the journeys of the Motor City and the Hellenic Republic into the red are startlingly similar, and the road ahead equally dire.

"At some point in their history, some truly stupid decisions were made, and at some point in the last few years, conditions changed that made what looked like a good move turn into a disaster," said NACM Economist Chris Kuehl, PhD, noting that, in Greece's case, it bought labor peace by offering more than it could afford to public sector workers and retirees. "The litany of giveaways is long and there was never a point where Greece could really afford them," he added.

Detroit made similar mistakes, based on a big assumption that's now proven itself tragically incorrect. "In order to buy time with the public sector workers, they were offered generous benefits in retirement in lieu of pay raises during their working careers," said Kuehl. "It was a bargain based on the assumption that the city would expand and make more money in the future. The city leaders went annexation crazy at one point and created a city with more land area than communities with three times the population."

Much as the reasons for their struggles are the same, the roads to solvency for both Detroit and Greece will need to involve a combination of taxation, investment and government intervention if they're to have any chance of success. "The taxation system will have to expand, but with the realization that too much tax will drive people elsewhere. The investor has to be enticed to take a big risk, and that drives up the cost of that loan—just look at the yield on Greek bonds," Kuehl noted. "The third leg is government bailout. That is what is taking place in Greece...Thus far there is no promise of rescue from the state of Michigan or from the United States, but that position will have to change, and will once the city of Detroit makes the same adjustments and the same promises that Greece had to make."

Most depressing among the many connections between Detroit and Greece is the fact that their renewal won't be paid for by the people who instituted these disastrous policies in the first place. "The people who will take the brunt of the assault are not the ones that made the bad decisions and behaved stupidly," said Kuehl. "It will be the hapless people who simply ended up living in these communities."

- Jacob Barron, CICP, NACM staff writer

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Report: Risk Management Increasingly Important, but Companies Struggling to Convey Its Value

A report sponsored by KPMG International found that risk management has become increasingly important to companies, even though organizations have struggled to communicate its value to stakeholders.

The survey, titled "Expectations of Risk Management Outpacing Capabilities—It's Time for Action" was conducted for KPMG by the Economist Intelligence Unit (EIU) of The Economist. It asked more than 1,000 C-level executives worldwide about their perception of the risk management function and how effectively they've promoted a risk-minded philosophy throughout the organization. Forty-seven percent of respondents said that they considered risk management essential for adding value to their overall business, an attitude that has presumably only grown over the last few years, as the survey also found that risk management investment has recently ballooned as a percentage of revenues. Furthermore, 66% of participants expected their investment in risk management to increase in the next three years.

Driving the increased focus on risk management is a unique collision of challenges that has caught many companies unprepared, including growing interest in riskier emerging markets, increasingly complex regulatory environments and greater competition. "These challenges are building faster than most organizations' abilities to manage with agility, knowledge and a resilient risk-aware culture," said the report's executive summary. "Thus, the gap is widening and we are at a turning point, warranting an even stronger capability to master and optimize risk."

Even though the demand for risk management expertise has never been higher, the report found that companies need to improve how they measure risk management's return on investment (ROI) and how they convey its processes, value and effectiveness to key stakeholders. Thirty percent of respondents said that their company only measures risk management by reviewing past results or risk events to make an assessment, while 28% answered that their companies had no mechanism to measure the function's ROI at all.

Complicating the desire among company stakeholders for more sophisticated, cutting edge risk management programs is the fact that most organizations aren't very proficient at incentivizing their employees to make risk-based decisions. The KPMG survey found that 43% of respondent companies either have a weak, informal link between risk management and compensation, or no link between those two whatsoever. "A way to improve alignment is to provide employees from top to bottom with incentives that will motivate them to weigh skillfully the risk and opportunity in every business decision they make," the report recommended.

A copy of the executive summary can be found here.

- Jacob Barron, CICP, NACM staff writer

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More Problems for the Once-Mighty BRICS

The BRICS (Brazil, Russia, India, China and South Africa) continued their fall from emerging economic strength in recent weeks starting with news that China's growth rate declined in the second quarter. It marked two consecutive periods of easing, though its 7.5% growth rate still tracked higher than most. More negative news continued to build among some of its colleagues within the bloc.

South American-based Business News Americas reported this week that corporate credit demand in Brazil decreased by 4.7% during the first six months of 2013 as compared to the same period in 2012. Meanwhile, Brazil also may have eroded some of its own negotiating power, and that of its neighbors, where trade is concerned. Officials have reportedly pushed other members of the Mercosur, including Argentina and Uruguay, to negotiate more rapidly with trading partners like the European Union in an effort to boost exporting in the near term.

In India, a new Business Today-C fore Business Confidence Survey found business optimism slumping to its lowest level in more than two years. Nearly half of the 500 CEOs and CFOs polled reported worsening conditions during the last quarter. And about 75% of businesses predicted the economy dipping further in the coming quarter. Two-thirds projected a near-term look to overseas markets for investment opportunities soon.

Meanwhile, South Africa was assailed again by a U.S.-based ratings agency, this time Moody's Investors Service. The ratings agency affirmed its "Baa1" assessment of South Africa's government debt ratings and maintained a negative ratings outlook. It explained the ongoing negative outlook by citing:

  1. "Continued sociopolitical pressures on the macroeconomic policy framework headed into next year's parliamentary election against a backdrop of slow growth."
  2. "The weakened outlook for the mining sector, which is the country's single largest employer and main source of foreign exchange earnings."

- Brian Shappell, CBA, CICP, NACM staff writer

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Surprisingly Positive News Emerges in EU Economic, Credit Studies

A pair of studies released this week found potential early signs of recovery in a beleaguered European Union that has long been waiting for optimism.

A European Central Bank (ECB) study on bank-based credit lending found conditions may be easing. The Euro Area Bank Lending Survey for the second quarter noted the net percentage of banks tightening credit standards on businesses seeking loans did not increase over the last three months. ECB analysts noted this with some surprise.

Additionally, banks' perceptions of the risk of lending to EU-based companies have stabilized, even if at historically elevated levels. Still, the ECB took the stabilization as a good sign. And, while loan demand remained weak, at least the pace of the decline in applications has moderated. Tensions regarding sovereign debt levels continue to linger, but those concerns have become "more muted" of late, the ECB noted.

Meanwhile, a survey by Markit, a global financial information services firm, found EU member nations are at their collective best, from a manufacturing standpoint, in 18 months. The Markit Flash Eurozone Purchasing Managers' Index (PMI) reached 50.4 in July, up from 48.7 in June. Many market analysts characterized that as unexpected. Within the statistics, manufacturers reported the largest monthly increase since June 2011. Two of the best manufacturing rebounds were noted in Germany and France, which reported the largest rise in production in 17 months. Service sector activity also showed signs of stabilizing.

Markit Chief Economist Chris Williamson said the reading "provides encouraging evidence to suggest that the euro area could, at long last, pull out of its recession in the third quarter." He added that, based on the findings, there is finally "light at the end of the tunnel" for nations racked by austerity actions.

Markit also published PMI results for China and the United States this week. The HSBC Flash China Manufacturing PMI tracked at an 11-month low of 47.7 in July, down from June's 48.2 reading. The Markit Flash U.S. Manufacturing PMI reached a four-month high of 53.2, up from June's 51.9, on the quickened pace of manufacturing sector growth.

- Brian Shappell, CBA, CICP, NACM staff writer

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Senators Try to Saddle Fed with New Dual Mandate in Monetary Policy Hearing

When Congress amended the Federal Reserve Act in 1977, it charged the Federal Reserve Board with a dual mandate to mitigate inflation while promoting maximum employment.

While the recession highlighted this role, it also put the Fed's actions under increased scrutiny that has yet to wane. And so, when Fed Chairman Ben Bernanke delivered the Fed's semi-annual monetary policy report to the Senate Committee on Banking, Housing and Urban Affairs last week, lawmakers from opposite sides of the aisle charged the Fed with a new dual mandate: consider winding down the Board's balance sheet, but maintain asset purchases as long as necessary.

Bernanke noted in his testimony that there had been gradual, but still less than satisfactory, improvement in the labor market, as the unemployment rate in June was about a half percentage point lower than in the months before the Federal Open Market Committee (FOMC) had initiated its current asset purchase program. At the same time, inflation continues to run well below the Fed's 2% target, indicating that the Board is adhering tightly to its statutory dual mandate of balancing stable prices with maximum employment.

For this reason, Bernanke pledged more of the same. "With unemployment still high and declining only gradually, and with inflation running below the Committee's longer-run objective, a highly accommodative monetary policy will remain appropriate for the foreseeable future," he said.

However, some have become concerned that ongoing asset purchases have placed too great a burden on the Fed's balance sheet, including Senate Banking Committee Ranking Member Mike Crapo (R-ID). "The Fed's balance sheet now stands at nearly $3.5 trillion dollars, with an additional $85 billion every month in long-term assets being added," Crapo said in his opening statement. "Beyond tapering, which is simply slowing the rate of growth of the Fed's balance sheet, is the more important issue of winding down the Fed's massive balance sheet."

On the other hand, Banking Committee Chairman Tim Johnson (D-SD) was more concerned that the Fed would cut back on asset purchases before the economy was really ready. "The Fed should not prematurely step on the brakes," Johnson said. "With consumer price inflation low, and the unemployment rate unacceptably high, the Fed must continue to take action to support employment."

Ultimately the Fed is its own independent entity, and will do as it sees fit. Its statutory mandate to balance inflation with employment will remain its priority, but the post-recession Fed now also finds itself the target of more political pressure, as both sides of the aisle aim to bend its actions to their respective party's platform.

- Jacob Barron, CICP, NACM staff writer


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