NYT: Detroit Bankruptcy Shows How Wall Street Wins

Detroit's bankruptcy case is another example of how Wall Street wins, according to The New York Times.

Fixing Detroit's financial dilemma is supposed to be done by "shared sacrifice" between pensioners and municipal bond investors. Nice idea in theory, but the big banks — which helped cause the city's financial problems — don't seem to be sharing that sacrifice, according to The Times' editorial board.

Meanwhile pensioners are vulnerable, as their pensions are not federally insured and many do not get Social Security.

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Under its settlement in the works with creditors, the city will pay approximately $250 million to UBS and Bank of America to settle derivative deals, know as interest rate swaps.

In the swap deals, the banks would pay the city if rates rose, while the city would pay the banks if they fell. As it turned out, rates fell and the city had to pay the banks about $50 million a year and pledge $11 million a month in casino tax revenue as collateral.

Under the settlement, which still needs to be approved by a bankruptcy judge, the banks agreed to take a 25 percent haircut. That doesn't mean they'll suffer, The Times notes, as they've already made money of the swaps.

"The banks' 25 percent hit is nothing compared with the 90 percent cut to pensions suggested by the city — a cut that would be disastrous in both human and political terms and that the State of Michigan must prevent from happening," The Times argues.

"Municipal officials are prey for Wall Street," the paper asserts.

The Dodd-Frank Act law instructs regulators to improve protections for municipalities and other clients who deal with Wall Street. But the Securities and Exchange Commission has yet to complete rules, and the Commodity Futures Trading Commission's rules are so weak, the newspaper says, they practically invite banks to exploit municipalities.

"The special treatment banks receive when debtors are in or near bankruptcy," the editorial board states, "is unfair and economically destabilizing."

Banks' swap deals are inadequately regulated and typically not subject to court rulings. In Detroit's bankruptcy case, banks are paid before other secured creditors, which is destabilizing because it encourages recklessness, according to The Times.

Ironically, Detroit's swaps deals worsened its pension obligations, according to The Wall Street Journal. They were supposed to help alleviate its debt load, but ended up cutting off access for the casino revenue.

The bankruptcy case will probably set precedents for handling swaps counterparties, as well as bondholders and pensioners, Reuters predicts.

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