Manhattan Institute for Policy Research.
search  
 
Subscribe   Subscribe   MI on Facebook Find us on Twitter Find us on Instagram      
 
 
   
 
     
 

Politico

 

Why Detroit Needs Bankruptcy

December 04, 2013

By Stephen Eide

Detroit is now literally bankrupt. And though they might not realize it, residents of the Motor City should celebrate this happy outcome.

On Tuesday, a federal judge ruled that Detroit had satisfied the eligibility requirements for Chapter Nine municipal bankruptcy, the most important of which are that the city is insolvent and has no practical way to negotiate down its back-breaking debt load outside of a federal courtroom. Detroit may now proceed to develop a so-called "plan of adjustment," which will specify what debt obligations it intends to cut, and by how much. Had Judge Steven Rhodes denied the city access to bankruptcy, it could have faced years of litigation with creditors, and possibly hundreds of millions in legal fees. Bizarre, that any city should want to be bankrupt—but there aren’t many places like Detroit, for which ordinary fixes can’t suffice.

Not everyone agreed with Judge Rhodes’s decision. Union and retiree attorneys vow to appeal, concerned about what will happen to city worker pensions should the bankruptcy go forward. In a report issued before the ruling, the liberal think tank Demos argued that Detroit’s fiscal problems are best understood as a revenue shortfall caused by state aid cuts in the wake of the recent recession. Critics believe that state government could easily render bankruptcy unnecessary by providing Detroit with a rescue package composed of additional local aid and credit guarantees.

But a state bailout could only provide Detroit with temporary relief. Yes, Detroit has suffered major cuts in state aid, as did many other cities during the recession. It nonetheless still receives more local aid on a per capita basis than all other large and mid-sized cities in Michigan, according to the Citizens’ Research Council of Michigan. On more than one recent occasion, notes the Mackinac Center, the Michigan state government granted Detroit extra revenue-raising abilities to overcome a budget squeeze presumed to be temporary. And—urbanists take note—what did Detroit gain from this enhanced local autonomy? The highest taxes among Michigan’s major cities.

At some point in the long road ahead back to fiscal self-sufficiency, it might be appropriate for Lansing to do more, if for no other reason than to ensure that other Michigan communities don’t see their credit access impaired by Detroit’s struggles. But calls for a state bailout at this stage ignore the ineffectiveness of past efforts and, moreover, what does Detroit have to give in exchange? Any bailout would need strings, such as more state oversight, but Michigan already took over the city in March. Reform should precede revenue and reform, unfortunately, will require bankruptcy.

Lurking behind all the legal and policy disputes over whether Detroit needs bankruptcy is one word that strikes fear into the hearts of American mayors everywhere: pensions. Prior to filing for bankruptcy, the city’s emergency manager, Kevyn Orr said that "significant cuts in accrued, vested pension amounts for both active and currently retired persons" would be needed to make the city solvent. Orr has already moved to cut retiree health benefits. Without bankruptcy, negotiations with creditors would remain under Michigan state law, which provides constitutional guarantees to pension benefits. In a big win for the city, Judge Rhodes, in issuing his ruling, made clear that pension cuts are indeed a legal possibility in federal bankruptcy.

Detroit’s pension mess, already complicated by this constitutional question, acquired added intensity from charges that Orr hyped up the size of the liability to justify bankruptcy. Federal law only allows for municipal bankruptcy in instances of "cash flow insolvency," meaning a city’s bills are coming due at a rate faster than it can pay them. An eye-popping debt total, backed by meager assets, cannot alone make a city eligible for bankruptcy (that would be "balance sheet insolvency"). Orr’s critics argue that pension costs pose a cash flow threat only under unconventionally conservative accounting assumptions.

No one factor, of course, drove Detroit to file for bankruptcy. The city’s tax base has been cratering for years, and its government is service-delivery insolvent, meaning it can’t cut costs anymore without endangering its citizens. Services are being strangled by a variety of debt payments. Orr pegs the pension liability at $3.5 billion, but even that figure is dwarfed by what the city owes for retiree health care, $5.7 billion, not to mention the billions more owed to Wall Street creditors.

Orr’s pension valuation method only looks extreme measured against the notoriously lax accounting standards of the public sector. Detroit has a long history of pension mismanagement. In 2005, instead of paying its full pension bill, Detroit borrowed money from credit markets, then attempted to secure fixed interest rates on that debt through a risky swaps transaction. The city now owes more than $2 billion for this failed shortcut.

It gets worse. Over two decades, Detroit passed on "excess" annual investment earnings to retirees in the form of "13th check" payouts, thus depriving its retirement systems of almost $2 billion. Without cuts, Detroit’s retirement benefit costs will consume hundreds of millions in coming years that the city desperately needs to fund streetlight maintenance, blight removal, public safety and other services.

Detroit’s near-term goals should be arresting depopulation and regaining access to the bond market. Bankruptcy, Detroit’s least bad option, will help achieve those goals, but that does not mean it might provide similar assistance to the many other struggling U.S. cities. Federal law purposely makes bankruptcy a last-resort option, thereby encouraging state-level solutions, even if they are not always forthcoming. Sadly, for Fresno, Scranton and other townss plagued by excessive retirement benefit debt and stagnant economic growth, things are going to have to get worse before they get better.

Original Source: http://www.politico.com/magazine/story/2013/12/why-detroit-needs-bankruptcy-100652.html

 

 
PRINTER FRIENDLY
 
LATEST FROM OUR SCHOLARS

The Real Challenge When Police Use Lethal Force
Stephen Eide, 12-15-14

Why Cops Need To Sweat The ‘Small Stuff’
Nicole Gelinas, 12-08-14

A Bill To Loosen Police Discipline
E. J. McMahon, 12-08-14

More Subsidies For Big Wind
Robert Bryce, 12-08-14

Bill Slanders His Cops
Heather Mac Donald, 12-07-14

What The Numbers Say On Police Use Of Force
Steven Malanga, 12-04-14

Detroit's Bankruptcy and Its Painful Reforms
Stephen Eide, 12-04-14

The EPA Pours On The Pain With New Ozone Regulations
Diana Furchtgott-Roth, 12-03-14

 
 
 

The Manhattan Institute, a 501(c)(3), is a think tank whose mission is to develop and disseminate new ideas
that foster greater economic choice and individual responsibility.

Copyright © 2014 Manhattan Institute for Policy Research, Inc. All rights reserved.

52 Vanderbilt Avenue, New York, N.Y. 10017
phone (212) 599-7000 / fax (212) 599-3494