updated 7/22/2013 5:17:59 PM ET 2013-07-22T21:17:59

The bankruptcy will probably continue without outside help, and retired public employees could suffer major consequences.

The first hearing in Detroit’s municipal bankruptcy is set to occur this week. Thus begins what could be a multi-year process, beset by legal challenges, political protests, and dissenting creditors. Very little is certain at this stage in the proceedings, but this much is clear: Detroit will have to resolve its fiscal crisis without the assistance of state and federal authorities. Retired public employees receiving pensions could suffer major consequences, depending on how Michigan courts answer crucial legal questions.

Federal judge Steven Rhodes will hold the municipal bankruptcy’s introductory hearing on Wednesday, at which time he’ll consider a request to insulate the proceedings against various legal challenges. On Friday, Ingham County Judge Rosemarie Aquilina declared the bankruptcy filing unconstitutional. Article 9, Section 24 of the Michigan state constitution says that pension benefits are a “contractual obligation … which shall not be diminished or impaired.”

While Aquilina’s ruling gave a boost to opponents of the Chapter 9 filing, it is unclear whether Aquilina’s state constitutional concerns will hold up in higher courts. Detroit Emergency Manager Kevyn Orr has not withdrawn the city’s bankruptcy petition, and the state Attorney General has appealed the ruling. It is possible that a higher court would allow the bankruptcy to proceed, but order that retiree pensions be protected throughout the ordeal.

“I anticipate a higher court will, at the very least, narrow the ruling to clarify the circumstances under which this bankruptcy would be in violation of the state constitution,” said Jocelyn Benson, the dean of Wayne State Law School. Aquilina’s ruling, which demands that Orr withdraw the bankruptcy filing outright, is “much too broad.”

A higher court may also grant an Emergency Manager or bankruptcy court the right to overrule Michigan’s constitutional protection of retirement benefits. On that question, said Benson, the city is in “uncharted territory.”

Should a higher court rule that pensions are fair game, they would likely receive a drastic cut. Orr estimates that pension liabilities have contributed about $3.5 billion of Detroit’s $18 billion budgetary hole.

“I don’t see any kind of options, other than the state planning some kind of bailout or something, ” said Michigan State University economist Eric Scorsone. The only alternative is what Orr has described in interviews as an “adjustment” to public employee pensions.

As of this week, a major adjustment seems likelier than ever, as state and federal authorities have definitely rejected the possibility of a federal bailout.

“I do not view that as the right answer,” said Michigan governor Rick Snyder during a Sunday appearance on Face the Nation. In a Monday press briefing, White House press secretary Jay Carney described Detroit’s budgetary crisis as “something that Detroit and its creditors must solve.”

Snyder also indicated that city bondholders would likely have to accept a significant haircut of their own. Detroit owes about $5.9 billion to Water and Sewage Department bondholders, which accounts for the biggest chunk of the city’s long-term debt. Other government debt comes to $2.9 billion. Last month, Orr proposed that bondholders accept ten cents on the dollar instead of what they’re owed in total.

The other big piece of Detroit’s debt is $5.7 billion in unfunded retiree health care. Instead of instituting drastic cuts to retiree benefits, the city may attempt to unload some of its retired civil servants into Obamacare exchanges.

“Have the retirees go through the state exchange, and give them maybe a subsidy to help them pay for that insurance, so the city won’t directly pay for the insurance,” said Scorsone. Chicago is already working on implementing a similar proposal.


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