Detroit’s Bankruptcy: The Story Behind the Filing

by Aaron Levitt | July 31, 2013 6:57 pm

Disclaimer: The author’s arguments in this opinion piece are entirely his or her own and do not necessarily reflect the opinions of NerdWallet as a whole.

Detroit filed for the largest municipal bankruptcy in history on Thursday, July 18, and it’s going to hurt.  How did this happen, what does this mean for Detroit’s economy, and what is going to happen next?

Plummeting Human and Economic Capital

Unfortunately, it’s not like Detroit’s bankruptcy should be a total surprise; Detroit’s biggest export[1] over the last three decades wasn’t cars, but people. 25 percent of the city’s population fled the city limits between the 2000 and 2010 censuses, and 60 percent of the population vanished since its peak of 1.849 million in 1950.

Meanwhile, Michigan itself had hemorrhaged 450 thousand of the 900 thousand manufacturing jobs it had in 2000.

Fiscally, Detroit’s deficits[2] were devastating. Their cash flow statement pre-bankruptcy is a nightmare of red ink, bleeding out 327 million per year in deficits as of 2011, and had racked up debts of about $18 billion.

Translated to human terms, that’s a deficit of $444.60 for every man, woman and child in the city. A family of four would have to cough up an additional $1,778.40 every year just to keep the debt from getting worse.

The total Detroit debt amounted to $25,218 for every resident – a number that crept higher for every person who hit the 8-Mile Highway out of town.  Available assets won’t even come close to covering the shortfall. Some people are kicking around the idea that Detroit’s pension funds[3] are going to be able to collect just ten cents on the dollar.

The Gloomy History of Municipal Debt Nationwide

But wait, it gets worse.  If you’ve been reading this space for a while, we’ve been sounding the alarm on municipal debt. Analyst Merideth Whitney also sounded the klaxons in 2010, predicting 50 to 100 sizeable defaults in the coming months. Since then, municipalities have been buoyed up by lingering stimulus expenditures and a rebound in the housing market that helped boost property tax receipts. Munis had a little hiccup following Whitney’s gloomy prediction, but rallied again, and continued to rally through the Stockton, California bankruptcy, then the largest municipal Chapter 9 filing in U.S. history.

Well, the market doesn’t always notice when a fish dies. But this bankruptcy is like a massive humpback whale washing up on the beach; it stinks, it’s hard to ignore, and efforts to deal with the problem may lead to unpleasant and unintended consequences.

Detroit’s long and sordid road to federal bankruptcy court didn’t begin with the last recession. The seeds were sown when labor unions, sheltered temporarily from global competition by Pax Americana and the economic devastation of every viable competitor thanks to WWII, learned they could force huge concessions from American automakers.

After all, American skilled laborers and the post-war manufacturing plant unscathed by foreign bombers was the only game in town.

Management played along, failing to make the strategic case that after two generations of auto workers that were no longer productive but still collecting pension benefits, that newer upstart manufacturers without these oppressive long-term obligations would eat them alive. Detroit got fat, dumb and lazy, while the Big Three began building lousy cars and destroying their brand until Toyota, Hyundai, Honda, Mitsubishi, Mercedes, BMW and Nissan blew them up like a whale carcass.

Meanwhile, the actual City of Detroit had to compete in the labor market with the auto makers, and wound up committing itself to generous long-term pension obligations that it had no way of keeping. Attempts to raise taxes to cover them would only accelerate the depopulation of Detroit, leaving the debt burden to be distributed more and more heavily on the shrinking remaining population. As it happened, Detroit saw its tax base cut in half[4], even as pension obligations and promises mounted.

A Timeline: The Long Road to Bankruptcy

Perhaps something could have been done earlier – not to eliminate the damage but at least blunt it so that pensioners would recover 80 cents on the dollar instead of 10 cents. However, iconic mayor Coleman Young was driving white and middle class Detroiters out of town during his tenure in the 70s, and Mayor Kwame Kilpatrick, presiding during the relatively prosperous years 2002-2008 and who probably had the best chance to turn things around at the last minute, was too busy engaging in a pattern of corruption, bribery and fraud[5] to lead the city to face the ugly truth.

This disastrous long-term history of mismanagement and absence of strategic planning is, according to New York Times columnist Paul Krugman,  attributable to bad luck.[6] “For the most part the city was just an innocent victim of market forces,” Krugman writes – as if the city had gotten that way by losing a bar bet or something.

So what of the broader municipal market? Well, markets took it in stride when Stockton declared bankruptcy. But Detroit is different. Not only was Detroit nine times more populous than Stockton at Detroit’s peak, but it is still more than twice as populous – and defaulted on a lot more debt.

Further, Stockton is really a local California problem; Detroit is a marquee name in American industry. So since Detroit filed bankruptcy – and since the President told them to drop dead[7] when they requested a federal bailout,[8] we’ve seen a broad pullback in munis, and some outflows, but no panic selling.

Indeed, in the last two weeks, we’ve seen two healthy developments that are actually good for bondholders, in the long run:

  1. First, Detroit finally recognized the inevitable and filed for bankruptcy before things got even worse, and there would be even less to recover.
  2. Second, the Treasury Department’s refusal to fund a bailout for Detroit sent a positive message to cities like Chicago, New York, Philadelphia and other struggling municipalities nationwide: Get your act together, because you’re not getting bailed out either.

Secretary Lew’s refusal was a shot across the bow to free-spending states and cities – and a much-needed one.

 

 


Endnotes:
  1. Detroit’s biggest export: http://www.mlive.com/business/index.ssf/2010/07/while_obama_celebrates_new_man.html
  2. Detroit’s deficits: http://www.today.com/id/42179951/ns/us_news-life#.Ue3hU6W_elI
  3. Detroit’s pension funds: http://online.wsj.com/article/SB10001424127887324688404578545373282545626.html
  4. Detroit saw its tax base cut in half: http://www.slate.com/blogs/moneybox/2013/07/18/detroit_bankrupt_the_largest_american_city_to_ever_go_bust.html
  5. corruption, bribery and fraud: http://www.thenewsherald.com/articles/2013/03/12/news/doc513df2825b69f880535302.txt
  6. bad luck.: http://www.nytimes.com/2013/07/22/opinion/krugman-detroit-the-new-greece.html?_r=0
  7. American industry. So since Detroit filed bankruptcy – and since the President told them to drop dead: http://en.wikipedia.org/wiki/File:Ford_to_City.PNG
  8. federal bailout,: http://www.mlive.com/news/detroit/index.ssf/2013/07/us_treasury_secretary_says_no.html

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