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Eurozone Banks Stop Lending To Each Other

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The eurozone banks have stopped lending to each other in a clear sign that mistrust has entered the system. We already know that Deutsche Bank is 60 times over leveraged with a massive derivative exposure. As Irish economist Karl Whelan put it best “At any point in time, this thing can blow up”.

euroEUROZONE banks are refusing to lend to peers in other countries in the common currency bloc, signalling a worrying fall in confidence that appears to have worsened since the Cyprus bailout earlier this year, data analysed by Reuters shows.
European Central Bank data shows the share of inter-bank funding that crosses borders within the eurozone dropped by one-third, to just 22.5pc in April from 34.5pc at the start of 2008.

The silent retreat to within national borders is most pronounced in the troubled economies of southern Europe, but is even seen in Germany.

Cross-border inter-bank funding of German banks was down by 11.2pc year-on-year in March, equivalent to banks elsewhere in Europe withdrawing €29.5bn from its biggest economy.

Eurozone banks’ stock of lending to their Greek peers was a startling 68pc lower in April than in the same month a year earlier, equivalent to €18bn withdrawn. In Portugal, the decrease was roughly a quarter.

The ECB figures include lending between separate banks in different eurozone countries and within a single banking group to its cross-border units.

CYPRUS

Faltering confidence may be responsible for the reduction in cross-border lending, due in part to a bailout of Cyprus that closed one of its two main banks.

Lobbyists for the banking industry also say a soon-to-be-finalised EU law making it possible to impose losses, or “haircuts”, on bank creditors could hurt confidence.

“At any point in time, this thing can blow up,” said Karl Whelan, an economist at University College Dublin, warning of a potential spillover on to regular savers.

“We are relying on an absence of panic among depositors while we sit around and work out who to haircut. There is a risk of large-scale deposit withdrawals in Spanish banks, in particular. They are the obvious tinder box.”

A spokesman for the European Central Bank countered that the trend was due to a general shift towards secured lending and funding via retail deposits. Banks were deleveraging, which increases the importance of stable retail deposits. (Reuters)

Source: Irish Independent

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The Bond Bubble Has Been Pricked

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As Andy Haldane, Executive Director of Financial Stability at the Bank of England said to Members of Parliament in London last week,

“We’ve intentionally blown the biggest government bond bubble in history.”

Now having pricked that bubble through Bernanke’s taper comments it may now be a case of controlling that implosion. Thats the new game.

bubble-burstIn theory, the Fed could continue to print money and buy Treasuries and mortgage-backed securities, or even pure junk, at the current rate of $85 billion a month until the bitter end. But the bitter end would be unpleasant even for those that the Fed represents – and now they’re speaking up publicly.

“Savers have paid a huge price in this recovery,” was how Wells Fargo CEO John Stumpf phrased it on Thursday – a sudden flash of empathy, after nearly five years of Fed policies that pushed interest rates on savings accounts and CDs below inflation, a form of soft confiscation, of which he and his TBTF bank were prime beneficiaries. That interest rates were rising based on Fed Chairman Ben Bernanke’s insinuation of a taper was “a good thing,” he told CNBC. “We need to get back to normal.”

A week earlier, it was Goldman Sachs CEO Lloyd Blankfein: “Eventually interest rates have to normalize,” he said. “It’s not normal to have 2% rates.”

They weren’t worried about savers – to heck with them. They weren’t worried about inflation either. They were worried about the system, their system. It might break down if the bond bubble were allowed to continue inflating only to implode suddenly in an out-of-control manner. It would threaten their empires. That would be the bitter end.

Andy Haldane, Director of Financial Stability at the Bank of England, put it this way: “We’ve intentionally blown the biggest government bond bubble in history.” The bursting of that bubble was now a risk he felt “acutely,” and he saw “a disorderly reversion” of yields as the “biggest risk to global financial stability” [my take… Biggest Bond Bubble In History Is Turning Into Carnage].

Preventing that “disorderly reversion” of yields is the Fed’s job, in the eyes of Stumpf, Blankfein, Haldane, and all the others. The Fed should let the air out gradually to bring yields back to “normal.” So the Fed hasn’t actually changed course yet. It’s keeping short-term rates at near zero, and it’s still buying bonds. But it has started to talk about changing course – and the hissing sound from the deflating bond bubble has become deafening.

Long-term Treasuries went into a tailspin. The 10-year note had the worst week since June 2009, the days of the Financial Crisis; yields jumped 39 basis points (13 bps on Friday alone), to 2.55%. Up from 1.66% on May 2. And almost double from the silly 1.3% that it briefly bushed last August.

The average 30-year mortgage rate increased to 4.17%, from 3.59% in early May. In response, the Refinancing Index crashed by almost 40%. Banks have sucked billions in fees out of the system via the refinancing bubble, but that game is over. And the Purchase Index dropped 3% for the week, a sign that higher rates might start to impact home purchases.

Then there was the junk-bond rout. They’d had a phenomenal run since the Fed started its money-printing and bond-buying binge. Average yields dropped from over 20% during the Financial Crisis to an all-time insane low of 5.24% – insane, because this is junk! It has a relatively high probability of default, and then the principal vanishes. That was on May 9, the day the rout started. The average yield hit 6.66% on Thursday. Investors have started to take a gander at what they’re buying and would like to be compensated for some of the risks that they’re suddenly seeing again. The feeding frenzy for yield is over. A sea change! Some companies might not be able to find buyers for their junk. And there will be defaults.

To preserve the system, as dysfunctional as it has become, the Fed has set out to tamp down on that feeding frenzy for yield, the hair-raising speculation, and blind risk-taking that its easy money policies have engendered – that is, financial risk-taking which doesn’t create jobs and doesn’t move the economy forward but just stuffs balance sheets with explosives. With its vague and inconsistent words, the Fed pricked the bond bubble but now is scrambling to control the implosion and soften that giant hissing sound. It doesn’t want the bubble to go pop. Its strategy: sowing confusion and dissension so that investors would react in both directions, with violent swings up and down, not just down.

The first big gun to open fire on the “taper” promulgations was St. Louis Fed President James Bullard when he announced on Friday that he’d dissented with the FMOC’s decision “to authorize the Chairman” to discuss publicly “a more elaborate plan” for the taper and an “approximate timeline.” They were premature. “Policy actions should be undertaken to meet policy objectives, not calendar objectives,” he said.

As stocks were heading south, three hours before what might have been a very ugly Friday close, after Thursday’s plunge, Jon Hilsenrath was dispatched. He is considered a backchannel mouthpiece of the Fed, and markets feed on his morsels. “The markets might be misreading the Federal Reserve’s messages,” he wrote in the Wall Street Journal. Stocks turned around on a dime. Others chimed in. The cacophony grew. And any consensus of when the Fed might actually taper its bond purchases dissolved into hot air.

That’s the plan. To accomplish its goal of preventing, as Haldane called it, “a disorderly reversion” of yields, the Fed will redouble its efforts to spread dissention and uncertainty, to intersperse periods of misery with periods of false hope, to stretch out the process over years so that big players have time to reposition themselves – and make some money doing it, or fall off the cliff and get bailed out, while others will end up holding the bag. Which is how bubbles end.

Source: TestosteronePit

ANALYSIS: WHY THE REAL EU FUHRER IS NOW MARIO DRAGHI

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During the week the Telegraph broke the story of how the ESM will be used to bailout broke banks. The article from the Slog explores how all the power now resides with Draghi.

ANALYSIS: WHY THE REAL EU FUHRER IS NOW MARIO DRAGHI.

China’s Credit Bubble Unprecedented

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Whereas China may have helped to save the world in 2008, its ability to help global GDP has slowly been strangled by its own massive debt levels. Corporate and private sector debt has grown out of all proportions severely limiting China’s ability to grow its way out of its debt problems.  It’s not just Western banks we need worry about.

China’s shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts, Fitch Ratings has warned. Fitch warned that wealth products worth $2 trillion of lending are in reality a “hidden second balance sheet” for banks, allowing them to circumvent loan curbs and dodge efforts by regulators to halt the excesses.

The agency said the scale of credit was so extreme that the country would find it very hard to grow its way out of the excesses as in past episodes, implying tougher times ahead.

“The credit-driven growth model is clearly falling apart. This could feed into a massive over-capacity problem, and potentially into a Japanese-style deflation,” said Charlene Chu, the agency’s senior director in Beijing.

“There is no transparency in the shadow banking system, and systemic risk is rising. We have no idea who the borrowers are, who the lenders are, and what the quality of assets is, and this undermines signalling,” she told The Daily Telegraph.

While the non-performing loan rate of the banks may look benign at just 1pc, this has become irrelevant as trusts, wealth-management funds, offshore vehicles and other forms of irregular lending make up over half of all new credit. “It means nothing if you can off-load any bad asset you want. A lot of the banking exposure to property is not booked as property,” she said.

Concerns are rising after a string of upsets in Quingdao, Ordos, Jilin and elsewhere, in so-called trust products, a $1.4 trillion segment of the shadow banking system.

Bank Everbright defaulted on an interbank loan 10 days ago amid wild spikes in short-term “Shibor” borrowing rates, a sign that liquidity has suddenly dried up. “Typically stress starts in the periphery and moves to the core, and that is what we are already seeing with defaults in trust products,” she said.

Fitch warned that wealth products worth $2 trillion of lending are in reality a “hidden second balance sheet” for banks, allowing them to circumvent loan curbs and dodge efforts by regulators to halt the excesses.

This niche is the epicentre of risk. Half the loans must be rolled over every three months, and another 25pc in less than six months. This has echoes of Northern Rock, Lehman Brothers and others that came to grief in the West on short-term liabilities when the wholesale capital markets froze.

Mrs Chu said the banks had been forced to park over $3 trillion in reserves at the central bank, giving them a “massive savings account that can be drawn down” in a crisis, but this may not be enough to avert trouble given the sheer scale of the lending boom.

Overall credit has jumped from $9 trillion to $23 trillion since the Lehman crisis.

“They have replicated the entire US commercial banking system in five years,” she said.

The ratio of credit to GDP has jumped by 75 percentage points to 200pc of GDP, compared to roughly 40 points in the US over five years leading up to the subprime bubble, or in Japan before the Nikkei bubble burst in 1990. “This is beyond anything we have ever seen before in a large economy. We don’t know how this will play out. The next six months will be crucial,” she said.

The agency downgraded China‘s long-term currency rating to AA- debt in April but still thinks the government can handle any banking crisis, however bad. “The Chinese state has a lot of firepower. It is very able and very willing to support the banking sector. The real question is what this means for growth, and therefore for social and political risk,” said Mrs Chu.

“There is no way they can grow out of their asset problems as they did in the past. We think this will be very different from the banking crisis in the late 1990s. With credit at 200pc of GDP, the numerator is growing twice as fast as the denominator. You can’t grow out of that.”

The authorities have been trying to manage a soft-landing, deploying loan curbs and a high reserve ratio requirement (RRR) for banks to halt property speculation. The home price to income ratio has reached 16 to 18 in many cities, shutting workers out of the market. Shadow banking has plugged the gap for much of the last two years.

However, a new problem has emerged as the economic efficiency of credit collapses. The extra GDP growth generated by each extra yuan of loans has dropped from 0.85 to 0.15 over the last four years, a sign of exhaustion.

Wei Yao from Societe Generale says the debt service ratio of Chinese companies has reached 30pc of GDP – the typical threshold for financial crises — and many will not be able to pay interest or repay principal. She warned that the country could be on the verge of a “Minsky Moment”, when the debt pyramid collapses under its own weight. “The debt snowball is getting bigger and bigger, without contributing to real activity,” she said.

The latest twist is sudden stress in the overnight lending markets. “We believe the series of policy tightening measures in the past three months have reached critical mass, such that deleveraging in the banking sector is happening. Liquidity tightening can be very damaging to a highly leveraged economy,” said Zhiwei Zhang from Nomura.

“There is room to cut interest rates and the reserve ratio in the second half,” wrote a front-page editorial today in China Securities Journal on Friday. The article is the first sign that the authorities are preparing to change tack, shifting to a looser stance after a drizzle of bad data over recent weeks.

The journal said total credit in China’s financial system may be as high as 221pc of GDP, jumping almost eightfold over the last decade, and warned that companies will have to fork out $1 trillion in interest payments alone this year. “Chinese corporate debt burdens are much higher than those of other economies. Much of the liquidity is being used to repay debt and not to finance output,” it said.

It also flagged worries over an exodus of hot money once the US Federal Reserve starts tightening. “China will face large-scale capital outflows if there is an exit from quantitative easing and the dollar strengthens,” it wrote.

The journal said foreign withdrawals from Chinese equity funds were the highest since early 2008 in the week up to June 5, and withdrawals from Hong Kong funds were the most in a decade.

Source: Irish Independent

Margin Debt over 2.25% of GDP Signals Stock Market Crash

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Another signal that the stock market is over inflated and heading for a major correction is margin debt greater than 2.25% of GDP. Levels in April already show that this level has been hit. Previous stock market crashes have in common high margin debt greater than 2.25%. Will we be lucky this time around, unlikely.

What do 1929, 2000 and 2007 all have in common?  Those were all years in which we saw a dramatic spike in margin debt.  In all three instances, investors became highly leveraged in order to “take advantage” of a soaring stock market.  But of course we all know what happened each time.  The spike in margin debt was rapidly followed by a horrifying stock market crash.  Well guess what?  It is happening again.  In April (the last month we have a number for), margin debt rose to an all-time high of more than 384 billion dollars.  The previous high was 381 billion dollars which occurred back in July 2007.  Margin debt is about 29 percent higher than it was a year ago, and the S&P 500 has risen by more than 20 percent since last fall.  The stock market just continues to rise even though the underlying economic fundamentals continue to get worse.  So should we be alarmed?  Is the stock market bubble going to burst at some point?  Well, if history is any indication we are in big trouble.  In the past, whenever margin debt has gone over 2.25% of GDP the stock market has crashed.  That certainly does not mean that the market is going to crash this week, but it is a major red flag. The funny thing is that the fact that investors are so highly leveraged is being seen as a positive thing by many in the financial world.  Some believe that a high level of margin debt is a sign that “investor confidence” is high and that the rally will continue. 

“The rising level of debt is seen as a measure of investor confidence, as investors are more willing to take out debt against investments when shares are rising and they have more value in their portfolios to borrow against. The latest rise has been fueled by low interest rates and a 15% year-to-date stock-market rally.”

Others, however, consider the spike in margin debt to be a very ominous sign.  Margin debt has now risen to about 2.4 percent of GDP, and as the New York Times recently pointed out, whenever we have gotten this high before a market crash has always followed…

“The first time in recent decades that total margin debt exceeded 2.25 percent of G.D.P. came at the end of 1999, amid the technology stock bubble. Margin debt fell after that bubble burst, but began to rise again during the housing boom — when anecdotal evidence said some investors were using their investments to secure loans that went for down payments on homes. That boom in margin loans also ended badly.”

Posted below is a chart of the performance of the S&P 500 over the last several decades.  After looking at this chart, compare it to the margin debt charts that the New York Times recently published that you can find right here.  There is a very strong correlation between these charts.  You can find some more charts that directly compare the level of margin debt and the performance of the S&P 500 right here.  Every time margin debt has soared to a dramatic new high in the past, a stock market crash and a recession have always followed.  Will we escape a similar fate this time?

S&P 500

What makes all of this even more alarming is the fact that a number of things that we have not seen happen in the U.S. economy since 2009 are starting to happen again.  For much more on this, please see my previous article entitled “12 Clear Signals That The U.S. Economy Is About To Really Slow Down“.

At some point the stock market will catch up with the economy.  When that happens, it will probably happen very rapidly and a lot of people will lose a lot of money.

And there are certainly a lot of prominent voices out there that are warning about what is coming.  For example, the following is what renowned investor Alan M. Newman had to say about the current state of the market earlier this year

If anything has changed yet in 2013, we certainly do not see it. Despite the early post-fiscal cliff rally, this is the same beast we rode to the 2007 highs for the Dow Industrials. The U.S. stock market is over leveraged, overpriced and has been commandeered by mechanical forces to such an extent that all holding periods are now affected by more risk than at any time in history.”

Source: theeconomiccollapseblog.com

Deutsche Bank, 60 times Over-Leveraged and a $72 trillion Derivative Exposure

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paddle_storeWhoa, how close is Deutsche Bank to causing ABSOLUTE HAVOC in the eurozone? At a capital ratio of just under 1.68%, DB is leveraged up to 60x and with a derivative exposure of over $72.8 Trillion, I think the technical term is “they’re f**ked”.

 

Finally, if anyone is still confused where the pain is headed next, here is a list from Morgan Stanley of all Euro banks with a Core Tier 1 ratio that is so low, that the banks will soon regret not raising more capital in the period of calm that the ECB’s LTRO bought them.

Also, one bank is missing from the list above: Deutsche Bank. CT1/TA: 1.68%. Oops.

That’s right – Deutsche Bank was so bad that it wasn’t even allowed to appear on a screen of Europe’s most undercapitalized banks – and we helpfully pointed out its true capital ratio of just under 2%, and an implied leverage of 60x!

According to FDIC Vice Chairman Tom Hoenig, Deutsche Bank is horribly undercaptialized.

A top U.S. banking regulator called Deutsche Bank’s capital levels “horrible” and said it is the worst on a list of global banks based on one measurement of leverage ratios. “It’s horrible, I mean they’re horribly undercapitalized,” said Federal Deposit Insurance Corp Vice Chairman Thomas Hoenig in an interview. “They have no margin of error.”  Deutsche’s leverage ratio stood at 1.63 percent, according to Hoenig’s numbers, which are based on European IFRS accounting rules as of the end of 2012.

In other words, the slighest systemic shock in Europe and Deustche Bank gets it. And as Deutsche Bank goes, so does Germany, so does Europe, so does the world.

Immediately confirming Hoenig’s (and Zero Hedge’s) observations, was Deutsche’s prompt repeat that “all is well” and that “these numbers” are not like “those numbers.”

“To say that we are undercapitalized is inaccurate because if you look at the Basel framework, we’re now one of the best capitalized banks in the world after our capital raise,” Deutsche Bank’s Chief Financial Officer Stefan Krause told Reuters in an interview, when asked about Hoenig’s comments. “To suggest that leverage puts us in a position to be a risk to the system is incorrect,” Krause said, calling the gauge a “misleading measure” when used on its own.

Of course, DB’s lies are perfectly expected – after all it is a question of faith. So let’s go back to Hoenig who continues to be one of the few voices of reason among the “very serious people”:

Still, equity analysts said that while Deutsche Bank likely will meet regulatory capital requirements, its ratios look weak.

Hoenig pointed to the gain in Deutsche Bank shares in January on the same day it posted a big quarterly loss, because it had improved its Basel III capital ratios by cutting risk-weighted assets.”My other example with poor Deutsche Bank is that they lose $2 billion and raise their capital ratio. It’s – I don’t want to say insane, but it’s ridiculous,” Hoenig said.

A leverage ratio is a better method to show a firm’s ability to absorb sudden losses, Hoenig says, and he has floated a plan to raise the ratio to 10 percent. He said the 3 percent leverage hurdle under Basel was a “pretend number.”

Opponents of using such a ratio say that it ignores the risk in a bank’s loan books, and can make a bank with only healthy borrowers look equally risky as a bank whose clients are less likely to pay back their loans. It also fails to take into account how easily a bank can sell its assets – so-called liquidity – or whether it is hedged against risk.

Still, equity analysts said that while Deutsche Bank likely will meet regulatory capital requirements, its ratios look weak.

But is there anything to really worry about? Well, as ZeroHedge put it….;-)

But just as we were about a year ahead with our warning of DB’s “off the charts” leverage, so we wish to remind readers that some time around June 2014, the topic of Deutsche Bank’s

$72.8 trillion in derivatives, or about 21 times more than the GDP of Germany

, will be the recurring news headline du jour.

Recall from April: “At $72.8 Trillion, Presenting The Bank With The Biggest Derivative Exposure In The World (Hint: Not JPMorgan)” which for those who missed it, we urge rereading:

Source: ZeroHedge

Finally Detroit To Default

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It was a sad day for Detroit, a once proud American city but the writing has been on the wall for quite some time. Eventually on Friday it was announced that it would stop making payments on $2.5 billion of its total $17 billion dollars of outstanding debt. Kevyn Orr, the Emergency Manager for the City of Detroit, presented to the City’s creditors the plan ahead for Detroit’s future.

DetroitHBFDetroit said Friday

it would stop making payments on about $2.5 billion in unsecured debt and ask creditors to take about 10 cents on the dollar of what the city owes them in a move to avoid what bankruptcy experts have said would be the largest municipal bankruptcy in U.S. history.

Detroit Emergency Manager Kevyn Orr spent two hours with about 180 bond insurers, pension trustees, union representatives and other creditors outlining his plan for the city’s financial future, which includes a moratorium on some principal and interest payments, Reuters reported.

Under his proposal, underfunded pension claims likely would get less than the 10 cents on the dollar.

An assessment of the plan’s progress will come in the next 30 days or so.

Orr also announced that Detroit stopped paying on its unsecured debt Friday to “conserve cash” for police, fire and other services in the city of 700,000 people. The debt not being paid includes $39 million owed to a certificate of participation.

“We will not pay that today,” Orr told reporters after the meeting with creditors at a hotel at Detroit Metropolitan Airport in Romulus.

More than 42 percent of Detroit’s 2013 revenues went to required bond, pension, health care and other payments. If the city continues operating the way it had before Orr arrived, those costs would take up nearly 65 percent of city spending by 2017, Orr’s team said.

The team also said the proposal presented Friday is the one shot to permanently fix fiscal problems that have made the city insolvent.

“We’re tapped out,” Orr was quoted by WWJ-TV as saying. “We need to come up with a plan to restructure our debt obligations and our legacy obligations going forward — that is: pension, other employee benefits, health care, so on and so forth.”

Orr said everyone involved needs to come to grips with Detroit’s dire financial situation that has been worsened by years of procrastination and denial. He said his team is prepared for potential lawsuits from creditors not pleased with the arrangements under the plan.

“If people are sincere and look at this data, you would think a rational person will step back and say, ‘This is not normal … but what choice do we have?'” Orr said.

James McTevia, president of the Detroit-area turnaround firm McTevia and Associates, said once Orr had creditors’ attention Friday, he “drew a line in the sand and said everything behind here is frozen.”

“And going forward he is positioning the city of Detroit in a place where it can pay for goods and services without going into debt,” McTevia said.

Detroit’s fiscal nightmare didn’t occur overnight. It’s been decades in the making as city leaders took out bonds at high interest rates to pay bills Detroit’s general fund couldn’t cover.

“The average Detroiter has to understand this is a culmination of years and years of kicking the can down the road,” Orr said. “We can’t borrow any more money. We started borrowing from our own pension funds.”

The city’s budget deficit could top $380 million by July 1. Orr believes Detroit’s long-term debt is more than $17 billion.

The Washington-based bankruptcy attorney hired by Michigan in March reiterated that the chances of bankruptcy are 50-50 for Detroit, the largest U.S. city placed under state oversight.

Orr is nearly three months into the 18-month job. With little time remaining on his contract, there is no time to lose. The plan creditors received in the closed-door meeting may be the only one they get.

“There may be some room for negotiations, but not a lot,” Orr told reporters. “They need to have some time to digest what they have.”

Swallowing the proposal will be tough, especially for current and retired city workers whose health care and other benefits, as well as pensions, would be cut back.

“The firefighters are going to do what we can to keep the city stable now,” Detroit Fire Fighters Association President Dan McNamara told reporters after Friday’s meeting with Orr.

McNamara said creditors were told by Orr that “we’re in a death spiral.”

The city will not be able to back up some promises related to pension and post-employment health care and benefits. Orr is proposing a $27 million to $40 million health care replacement program that will partially rely on the federal Affordable Health Care Act, health exchanges and Medicare.

He also said $1.25 billion will be set aside from concession savings over 10 years for public safety, lighting and eliminating neighborhood blight. Improving the quality of life in the city will help attract more residents and businesses, which Orr’s team says would bring more tax revenue and increase the potential for creditors to recover more of what they are owed.

Creditors were told about plans to possibly change management of Detroit’s revenue-generating Water and Sewerage Department. A separate, freestanding authority would control the department, with some annual payments coming to Detroit and the city maintaining ownership of the system.

On Friday, Moody’s Investors Service downgraded a number of Detroit bonds, including its general obligation unlimited bonds. As a result, all Detroit bonds are now below investment grade.

Hetty Chang, a vice president with Moody’s, said “the emergency manager’s proposal to creditors indicates further debt restructuring.”

“We also believe the city’s risk of bankruptcy has increased over the last six months,” she said in a statement.

Read more: Fox News

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