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Analysis: Fiscal struggle puts Detroit under credit cloud

By Karen Pierog

(Reuters) - Detroit's fiscal clock is ticking down again as the city faces running out of money by the end of the year unless a political squabble between the mayor and city council can be resolved.

Without a resolution, the state of Michigan will not release cash to keep the city running. Mayor Dave Bing, who contends that bankruptcy or bond defaults are not on the horizon, is prepared to put city workers on unpaid leave to keep the struggling local government operating.

Credit rating agencies are warning that political and legal obstacles could derail plans to get Detroit back on solid financial footing. Moody's Investors Service last week pushed the city's credit ratings deeper into the junk category and warned of a heightened risk of bankruptcy or default over the next year or two.

An informal meeting of the city council has been called for Tuesday for an update on Detroit's financial condition.

Under current law, Detroit has no path that could lead it to federal bankruptcy court. Bettie Buss, a senior research associate at the Citizens Research Council of Michigan, a nonpartisan public policy group, said the state would have to appoint an emergency financial manager for the city who could decide to pursue Chapter 9 municipal bankruptcy as long as the state does not block the move.

The city of 700,000 has been hard hit by a steep population drop, years of severe budget deficits and escalating employee costs -- factors that led state officials to begin an intervention process about a year ago.

Detroit was able to avoid the appointment of an emergency manager by signing a consent agreement earlier this year that gives the state some oversight.

Progress under that deal has been slow, while a 2011 law that was used to craft parts of the agreement, including the ability to suspend collective bargaining agreements with unions, was repealed by Michigan voters on November 6. To take its place, state officials resurrected a former, weaker emergency manager law -- sparking a flurry of litigation challenging the move.

Terry Stanton, a spokesman for Michigan's Treasury Department, said Moody's downgrades of Detroit underscore the importance of having "a mechanism in place that can assist municipalities and school districts experiencing financial stress or in the midst of a financial emergency."

Governor Rick Snyder, who has expressed concern that repeal of the emergency manager law could open the door to municipal bankruptcy in his state, has been talking with legislative leaders about crafting a new law that could potentially be passed during a lame-duck session this month.

NEW LAW IN THE WORKS

Buss, of Citizens Research Council, said one legislative idea is to allow local governments to choose between filing for bankruptcy or getting a state-appointed emergency manager.

A replacement law is being discussed, but nothing has been fully drafted, Ari Adler, spokesman for Michigan House Speaker Jase Bolger, said on Friday.

"Speaker Bolger does not believe that cities going bankrupt is good for those cities, the state, or Michigan residents," Adler said. "The repercussions, both short-term and long-term, could be very detrimental."

In the meantime, a violation of the consent agreement could lead to receivership for Detroit. But Buss said a violation may be hard to prove as the deal lacks specific performance targets and timelines "that a lot of us felt were needed to hold Detroit's feet to the fire."

In the latest effort to spur reforms, a separate memorandum of understanding reached between Mayor Bing and the state in mid-November laid out specific conditions and deadlines for the city to win the release of $30 million -- money that would help the city avoid running out of cash by the end of this month.

But Bing and the city council failed to reach an accord on one of the conditions -- approving a contract with law firm Miller Canfield to handle legal work associated with the consent agreement, leading the state to withhold an initial $10 million payment to the city in November. The city council rejected the contract, citing potential conflicts of interest by the law firm and concerns over the legality of the contract.

Stanton said the state continues to insist Detroit meet the conditions in order to obtain the money, which was raised through bond sales earlier this year. Another $20 million is due the city on December 14, subject to other conditions, including the execution of contracts for an audit of dependents for medical benefits, payroll outsourcing and the retention of a restructuring team.

"Continued and protracted delays do nothing to solve the city's problems, but only promise to make them worse," Stanton said.

Detroit's prior cash crunch in June led to warnings that a payment on pension debt could be missed. However, a default was averted when a state judge dismissed a lawsuit brought by the city's top lawyer challenging the validity of the consent agreement.

With the city once again projecting it will run out of cash, Bing's administration said last month that unpaid leaves for workers would be used to prevent that from happening and that no debt payments will be missed.

"It doesn't look good for them right now. They're on their own little fiscal cliff," said Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management.

He said Michigan's biggest city could be headed for default as its cash and political situations deteriorate.

"When the politics come in conflict that's when you get defaults," Ciccarone said.

(Reporting by Karen Pierog, Editing by Tiziana Barghini and Dan Grebler)

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