Federalism and the Detroit Bankruptcy Case

Image: Wikipedia

Image: Wikipedia

Federalism, the contrarily named power-sharing agreement between the central [national] government and the state governments has been debated in various forms in courts through our country. The Detroit bankruptcy case stirs up two areas in the constitution that are particularly cumbersome to interpret thus making the Supreme Court the last pass as parties find loopholes and reasonable doubt in lower courts.

The Supremacy Clause in Article VI of the Constitution reads: “This Constitution, and the Laws of the United States which shall be made in pursuance thereof; and all treaties made, or which shall be made, under the authority of the United States, shall be the supreme law of the land; and the judges in every state shall be bound thereby, anything in the constitution or laws of any state to the contrary notwithstanding.”

Then the 10th Amendment says creates the mechanism for issues such as the Detroit bankruptcy to be volleyed around, “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

Scott Bomboy of the Constitution Center mentions that “the concept of nullification–that states can overrule federal laws–predated the Civil War by decades, and the ultimate issue of nullification (secession) was settled in the 1860s. Since then, there’s been a flow of federalism or states’ rights cases heading to the Supreme Court, on a regular basis” (Bomboy, 2013).

Bankruptcy lawyers say that argument faces an uphill legal battle because federal courts typically have the power to interpret state constitutions. It’s a key principal of law based on the Constitution that every federal court has the ability to determine its own jurisdiction. The federal court is also able to enjoin any state court action which will interfere with its jurisdiction.

Opponents of the Detroit filing for bankruptcy argue that the question is solely a state matter, placing it outside the reach of federal courts, a doctrine known as “independent and adequate state grounds” which is part of the basic framework of the American legal system that the U.S. Supreme Court is the ultimate arbiter of questions of federal law but the state courts are the ultimate arbiters of the laws of each state (Hortonville Joint School District No. 1. v. Hortonville Education Association, 426 U.S. 482, 488 (1976). Which concluded “We are, of course, bound to accept the interpretation of [State] law by the highest court of the State.” Granting the U.S. Supreme Court the authority (“jurisdiction”) to review state court determinations of federal law, but lacks jurisdiction to review state court determinations of state law (28 U.S.C. § 1257 courtesy of Cornell Law Institute).

This general rule is simple to apply in cases clearly involving only one body of law. If that law is federal, then the U.S. Supreme Court has jurisdiction to review the state court judgment; if it is state law, then it does not. However, because litigants can (and often do) raise federal claims in state courts, many cases are not so simple, and this general rule breaks down. State courts often dismiss cases raising federal claims because they fail to comply with state-law procedures, and in some cases federal and state law are not clearly distinct; instead they are intertwined. The adequate and independent state ground doctrine provides certain exceptions to this general rule and guides the U.S. Supreme Court’s exercise of jurisdiction over these complex cases (Cornell Law). For this reason I believe the issue to be a state issue and not a federal issue.

Generally, federally courts will deny discretion to review an issue it if it rests solely on state grounds. From CNBC, “Regardless of the ruling, bankruptcy law experts say, the case could involve multiple appeals to both state and federal courts – with little legal precedent to shape the outcome. Most of the several hundred cases that have been filed since the modern Chapter 9 code was amended in 1978 involve small municipal entities like water or sewer districts.”

Some political leaders and members of the media believe Detroit should be allowed to move through bankruptcy, while others are calling for federal intervention – and maybe even a bail out of Detroit.  Many news outlets reported that lawyers for the city have argued in court filings that they negotiated “in good faith” with the city’s creditors before filing for bankruptcy. The city also argued that it is insolvent, one key criteria allowing municipalities to file for bankruptcy.

Several creditors, including labor groups, have signaled that they plan to challenge the city’s eligibility to file for bankruptcy. The city’s pension boards have accused Emergency Manager Orr’s team of failing to negotiate in good faith over changes to retiree pensions (NPR) which I feel will be the single largest hang-up and possibility for a bailout scenario that Detroit has in order to salvage retiree benefits and incomes.

USA Today reports that some bankruptcy experts have predicted that Detroit’s case could last as long as three years [a large Californian case in Vallejo took one year to decide if it was even ELIGIBLE for bankruptcy in 2008 then another three years to be released from bankruptcy protection granted].

I feel that the city has a responsibility to pensioners who invested their careers and lives to a city which now cannot support them, YET, was extended credit to which they could not repay. Over the course of the last several years when credit was being extended I wholeheartedly believe that creditors were operating predatorily with regard to debt extension.

Since the 1960’s one could argue that Detroit’s “all eggs in the automotive basket” could fail at any change of trade wind and thus, creditors extending debt to a city of this nature were hedging on a foreclosure type status in lending massive amounts of money with a guaranteed return on this investment. This type of scenario in a buyout guarantees money to creditors who did not perform their due diligence when lending money and in considering a bailout they are subject to rewards that would be granted to extend the irresponsible lending practices of many large corporations. The federal system will allow Orr to pursue a “cram down” procedure in which he could ask the judge to force the reorganization plan onto dissenting creditors (USA TODAY) then when the money is gone, it’s gone. It would be my hope to support those that paid into the system [pensioners] first and then lastly take care of those that overextended Detroit’s debt particularly in the last decade when Detroit was failing fast.

I’m not a fan of additional layers of neither government, nor federal intervention on state matters in general; however, if the state doesn’t do its job in keeping the local government or municipalities in check in budgeting year-to-year and the community is unwilling or unable to uphold its bargain, change or intervention must occur somewhere. Ideally I think this happens in the state for the state and with the state leading the solution and not in the form of a bailout or buyout situation. If we start down this road, multiple municipalities, creditors, etc. will seek relief from the high Court instead of performing due diligence in lending or spending and that is a crisis for our nation and the world economy. Accountability and transparency standards must be strengthened as well as lending practices monitored as opposed to the borrow now and cross your fingers later approach to lending. I put a lot of responsibility and blame in this particular case on the lenders and their practices as primary fall guys. I think they made a bad bet, an irresponsible bet and should not be rewarded for their lack of investigation into a borrower.

Further investigation into the Headlee Amendment of 1978 and Proposal A points to a situation which when combined could have been aiding the case for debt accrual in Detroit for years. The Headlee Amendment which requires a local unite of government to reduce its millage when annual growth on existing property is greater than the rate of inflation and the legislation passed in 1994, Proposal A where local governments were allowed to “roll up” their millage rates when growth on existing property was LESS than inflation were two mechanisms placed in local governments to limit uncapped/capped taxable values. The combination of both the Headlee Amendment and then the counter of Proposal A of 1994 could have created a “perfect storm” scenario contributing to Detroit’s bankruptcy woes in that a community with an annual increase in uncapped property values would seem to benefit monetarily, until they actually trigger the Headlee rollback as they are treated as growth on existing property. The caps on taxable value of property increases creates a result that is less than inflation and kills property tax revenue in local governments rendering them unable to share any benefits of growth potentially based on existing property values. This makes it not within government interest to create an improved community/local economic environment as growth/profit is essentially restricted and ‘rolled back’ per the Property Tax Act.

The answer to this issue of Federalism will affect the entire country as other states like California and New York have similar laws as Detroit. As a practical matter, though, the conflict between federal law and state constitutionality may mean that Detroit must wait a long time before it knows how much it owes (Public Sector). Moreover, I think it is critical to examine the roll of politics in governance of large cities particularly ones that anchor large hubs of regional economic growth and see that Amendments and Proposals such as Headlee and A have the potential to wreak havoc when paired with economic downturns or indicators. Until the government runs more like a business than a nonprofit, it is my belief that we will see continued pension, borrowing and bankruptcy issues in a more widespread manner in years to come.

Sources:

Anonymous. (2012, April). Headlee Rollback and Headlee Override. Retrieved from http://www.mml.org/resources/publications/one_pagers/opp_headlee_override.pdf

Anonymous. (2013, July 18). Updated: Detroit has filed for bankruptcy, largest city in US history to do so. Retrieved from http://www.dailykos.com/story/2013/07/18/1224755/-Detroit-headed-for-Chapter-9-bankruptcy-Emergency-Mgr-Orr-to-file-paperwork-as-early-as-tomorrow#

Bomboy, Scott. (2013, July 27). Detroit bankruptcy case puts federalism on center stage. Retrieved from http://blog.constitutioncenter.org/2013/07/detroit-bankruptcy-case-puts-federalism-on-center-stage/

Bomey, Nathan and Snavely, Brent. (2013, July 30). Judge proposes fast pace in Detroit bankruptcy case. Retrieved from http://www.usatoday.com/story/news/nation/2013/07/30/detroit-bankruptcy-hearing-dates/2600139/

Editor. (2013, July 18). Detroit files for largest municipal bankruptcy in US history. Retrieved from http://federalistpress.com/detroit-files-for-largest-municipal-bankruptcy-in-us-history.php

Gelinas, Nicole. (2013, July 19). Detroit’s bankruptcy could end up in DC. Retrieved from http://www.publicsectorinc.com/forum/2013/07/detroits-bankruptcy-could-end-up-in-dc.html

Lockwood, Andrew. (2002). Office of Revenue and Tax Analysis Michigan Department of Treasury. SCHOOL FINANCE REFORM IN MICHIGAN PROPOSAL A: RETROSPECTIVE. Retrieved from http://www.michigan.gov/documents/propa_3172_7.pdf

Miller, Mark. (2013, July 17). Should you worry about Detroit’s Pension Woes? Retrieved from http://finance.yahoo.com/news/column-worry-detroits-pension-woes-195255744.html

Riley, Sean. (2013, July 23). The argument of statism versus federalism in Detroit. Retrieved from http://www.examiner.com/article/the-argument-of-statism-versus-federalism-detroit

Schoen, John W. (2013, July 23). It’s fed vs. state as Detroit heads to bankruptcy hearing. Retrieved from http://www.cnbc.com/id/100907431

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