Think Detroit, and then think Germany, or Belgium. It’s a stretch to be sure, but moving forward, this is exactly the kind of leap many financial services professionals will have to make.
Here’s why. Late last week, the city of Detroit—the largest city in the largest county in the state of Michigan, boasting a rich history in fields as diverse as automobiles and music—filed for bankruptcy, by far the largest of its kind in U.S. history. At the core of the massive filing is the simple fact that the city, after more than half a century of decline, can’t keep up payments on some $18 billion in debt. Even in a best-case scenario, it will only be able to pay out a small portion of that in the near future. (The reality might be more in the direction of a worst-case scenario.)
So who is it that’s holding all this debt? Well, that’s where those European markets come in.
The Detroit debacle, which has been so long in the making, has tentacles that reach all the way across the Atlantic to financial conglomerates in Europe, and the institutions and individuals who in turn hold all those bonds. Back in the middle of the last decade, a group of international financial services institutions (led at first by UBS) sold more than $1.4 billion of bonds. There were more rounds of financing later, and it’s (almost) easy to understand why: In those heady days, the lure of low-risk high-return bonds were too tempting to resist.
Fast forward to mid-2013, and it’s not just multinational conglomerates holding vastly devalued paper. (For the record, UBS has been in the news for facing a $50 billion loss, getting a bailout from the Swiss government, and being forced to overhaul its investment practices.) This time nationalized banks in places like Germany and Belgium are suffering too. The debt they collectively hold was once worth hundreds of millions; now, not so much. To compound the tragedy is the simple reality is that many of these institutions and individuals have already sustained significant losses in recent times. The Detroit filing promises to greatly add to that long list of woes.
On a related front, the bankruptcy is in an area that’s still somewhat grey—the size and complexity of this filing aside, it’s a fairly recent phenomenon with not much case law. Municipal restructuring, especially on this scale, is a new frontier, and there are even valid questions as to whether the filing is completely legal. A veritable army of bankruptcy lawyers and accountants is poised to enter the fray, incurring high bills in the process. Every party is acutely aware that every decision and every court ruling will set precedents for other cities in similar straits.
The same goes for the banks involved too. Apart from the scale of the problems, Detroit is far from alone in being in having troubling financial obligations; other cities and states took money from European lenders when the going was good, and those bills are coming due soon.
Who will be the next to go the Chapter 9 route, and which banks will be on the hook for it? We’ll find out soon.
This is just one reason why it’s why it’s so interesting to see the financial services industry’s reaction to potential markets like Iraq and Egypt. Companies such as Citibank and Standard are said to be exploring the idea of expanding into Iraq, which has virtually no banking industry left but will clearly need one to move forward. Meanwhile in Egypt—the site of so much recent turmoil—banking industry representatives are touting improvements in the nation’s economic indicators, including stock market spikes. That could be the first step toward drawing foreign investments.
It’s surely a strange world when torment in one country can be a welcome opportunity in another. But what these events also indicate is that good news in one year can spell disaster in the next.